Market perspective: now what?

Market-463Key Points
  • Stocks have gone on a wild ride, with the long-awaited correction finally occurring, amid sharp snapbacks. We believe volatility is likely to continue and patience is suggested.
  • With no sign of recession in the United States, a prolonged bear market seems unlikely. But the increase in market volatility, combined with the absence of inflationary pressures has left the US Federal Reserve uncertain as to the timing of its next step.
  • The death of the global economy has likely been greatly exaggerated, leading to potential investment opportunities.
Don’t just do something, sit there!

“Everyone has a plan until they get punched in the mouth.”—Mike Tyson.

We would not normally quote Mike Tyson, but his words resonate lately. Investors are wondering what to do - buy the dips, sell the rallies, or sit tight? First, investment decisions should never be made on emotion, which tends to dominate at times like this. It can be difficult to stomach moves such as we’ve seen recently. But investors who have an investing plan in place should indeed just sit there, let things calm down, and continue with the plan already put in place. If additions to equity positions are required to keep portfolios in balance, the pullbacks we’re seeing can provide opportunities. But we do not think investors should be aggressive in their positioning. Volatility across asset classes is likely to persist, and further downside is possible; but we caution about trying to time the bottom of the market. Corrections typically take time to go through their bottoming processes, but changing your long-term strategy in reaction to the market’s short-term moves is not wise.
What happened?

Many fingers have been pointing toward China in the “blame game” that is always popular during market corrections. Yes, China’s growth is slowing; but that is not new news. Yes, China made a change to its exchange rate setting mechanism - going from a de facto peg to more of a floating system. But the “devaluation” amounted to 3% versus the 30% appreciation in its currency over the past decade. Yes, China appears to have botched its efforts to support their crashing stock market. But when China’s market bubble was inflating, our market turned a blind eye. We view these forces as straws more so than causes.

Likely exacerbating the wild day-to-day, and intra-day, swings is the prevalence of high frequency trading (HFT) and other algorithmic trading strategies. Where a correction such as we’ve seen recently might have occurred over several weeks 20 years ago, computer algorithms can compress time frames now, resulting in a condensed wild ride like we’ve seen. The result was a pretty sharp downturn. So why shouldn’t investors be more concerned this is just the beginning of something more serious?
No recession in sight

Sustained bear markets have typically not occurred outside of close proximity to an economic recession - and data isn’t showing a strong likelihood of that in the near future. The US is the world’s largest economy so we need to watch what is happening there as this can affect the rest of the world economies. US real gross domestic product (GDP) growth has been chugging along at roughly 2.7% over the past two years with no sign it is likely to drop significantly. Various reports indicate a drop in the US manufacturing index as a result of the Chinese slow down and some commentators spread alarm over this. However, the manufacturing industry represents only 12% of the US economy so a small downturn in US manufacturing is not something to be too concerned about over the long term.

A bright spot for the US economy - and helping to boost second quarter GDP - has been housing. The National Association of Homebuilder Index rose to the highest level in a decade, while new home starts and existing home sales both rose to roughly eight-year highs. And construction spending is up over 70% year-over year! This all leads to more confident consumers who tend to spend more - leading to a further recovery in the US economy.

Additionally, unemployment rates have been falling in the US - down to a multi-year low of 5.1% at the end of August 2015. This signals a steady improvement in the world’s largest economy.
So what to do?

Stay calm and carry on. Easy to say but hard to do. The US economy remains healthy, and recent stock market volatility has changed very little of that story, so we don’t believe your investment plan should change either. We still think the bull market is intact as global monetary policy is loose, economies aren’t falling off a cliff, and the US consumer is in good shape, supported further by falling commodity prices. Globally, the story is somewhat similar—major economies don’t appear to be falling off a cliff, and investors should turn their attention to the increasingly dominant services side of the global economic ledger.

However, if you have any concerns, give your Milestone adviser a call.