How This is a Market Selloff with little Fundamental Economic Impact
August 27, 2015
Highlights
- S&P 500 decline of 9.29%*
- We believe this is a market selloff with little fundamental economic impact
- Future drivers of market fluctuations will be psychology, economics, and valuations
Volatility has increased significantly through the month of July in equities both in the U.S. and throughout the world. It has been more than 46 months** since we have seen the last 10% correction. This correction is increasing investor anxiety. Investors should not panic, but instead, review the fundamental economics of the pullback and try to evaluate risks and opportunities.
As we try to access the potential depth of the correction, we look to which factors are contributing to the current pullback. Many economists agree the primary drivers of all market corrections are psychology, economics, and/or valuations. Psychology tends to drive the immediate volatility and is also the most unpredictable component of the three factors. Our investors should try to minimize the psychological components and instead concentrate on the economics and overall valuations. These factors drive large investor actions and these two components eventually drive market movements over the long term.
Looking through the global economic outlook, the primary catalysts to this correction comes from falling commodity prices, the economic data from China, and the expectation of increased interest rates. *
- Commodity prices, in general, have seen a significant correction. Oil prices continue to slide. Increase in supply and decrease in demand are the primary contributing factors to this devaluation. Many economists have pointed to this devaluation as an indication of deflation. Deflation is generally seen as bad. Deflation can come in two forms though. Price deflation in oil significantly boosts disposable income for the consumer. Commodity deflation does not have the same impact as wage deflation. Wage deflation is not happening as we recently had a strong July jobs report. Therefore, we feel devaluation will be isolated to certain market segments (such as energy and mining), but should help the economics of the consumer.
- China of 30 years ago no longer exists. This change is a significant factor in the context of global economics. China is the world’s second largest economy behind the United States and accounted for 38% of global GDP Growth*** in 2014.The sharp decline in the market prompted the Chinese government to institute several polices. The one policy that caught most everyone’s attention was the intentional devaluation of their currency. Many economists feel this effort was to help support exports. A weaker Yuan would increase demand for exports as China is a global manufacturer. Since the Yuan moves with the dollar, the effects of the recent dollar strength makes exported goods and services more expensive to other countries. What most people are missing is that this move also improves China’s standing for a reserve currency. While the devaluation is interpreted as a deceleration in their economy, it is not the only objective of this move.
- Interest rates have been persistently low for some time. The Fed has positioned itself for a rate increase this year. There are now lowered expectations and increased uncertainty around the timing of the rate increase. Uncertainty is almost never good for markets. It’s important to note a rate increase usually follows fundamentally better economic data.
When we rationalize the catalysts for this market downturn, they don’t appear to be supported by compelling economic data. There are weaknesses, but many other indicators point to a continually expanding economy. Labor is doing well, we are seeing a pickup in retail sales, auto purchases increased, we recently had an uptick in new housing sells, and as I mentioned before, we had a solid July jobs report. Growth looks acceptable.
Our firm does not believe, at this time, the market selloff will lead to larger and more significant economic problems. This type of selloff has happened frequently. In 1987, the stock market fell considerably more than this one has thus far and very little economic reaction occurred. More similar to today, the problems in Asia in 1998 did not translate to significant problems for the U.S. economy. Even the 2011 fear from Europe and a government shutdown caused a market selloff with relatively little economic impact. We believe this will likely be the same scenario.
There is always the possibility the market downturn could get worse and the news media could degrade investor confidence. For this reason, we continue to monitor the prevailing economic conditions. We have worked with clients to understand their financial goals, risk tolerance and time horizon and we believe in the power of diversified portfolios.
We will continue to look for opportunities in valuations and want our clients to resist the temptation to make knee-jerk reactions. The focus should be on quality assets, strong corporate balance sheets, and dividends. This is especially important in times of market stress. Our Acumen Wealth Advisors team is here to answer any questions you may have.
Market Insights by Reese Veltenaar
*Source: Morningstar, August 2015
**Source: Bahl & Gaynor, August 2015
***Bloomberg Business, July 13, 2015
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by NFP Advisor Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Using asset allocation or diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions. S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.
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