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Market Gyrations

The market moves over the last month have been quite volatile, and we understand that this can be disconcerting. Today’s events are no exception, and we wanted to pass along our perspective.

As we are composing this email, the markets have fallen from their all-time highs back in May, most major indices are now in a market correction (defined as a decline of 10% or more).

See below:

INDEX

Dow Jones Industrials

S&P 500

All Country World Index

YTD

-8.1%

-8.0%

-8.7% 

1-Year

-8.5%

-6.8%

-11.5%

All-time high

-14.3%

-15.0%

-20.2%

Reasons for the market correction are as follows:

  • A slowdown in China
  • Lower oil prices
  • Concerns of a global economic slowdown
  • Market valuations

Market corrections are dramatic in character, and are driven by fear from outside event(s) such as those listed above. Often, corrections will be brought on at the beginning of a change in Fed policy. The Fed just started raising rates in December for first time in ten years, and the markets have been in decline since the announcement of the rate-increase.

Market corrections are normally short-lived. That being said, they can occur at any time, and are quite common. According to Deutsche Bank, a market correction occurs on average once every 357 days (yearly).  In 2011 there was a 19% pullback in the stock market, but the markets would not see another correction for three full years until the summer of 2015. In three years’ time it is easy to forget how volatile markets can be.

The normal concern is that it may be the start of a more pronounced bear market (defined as a decline of 20% or more). Bear markets are normally born out of an economic recession. In this case, we see no indications indicating a recession is looming in the domestic or developed international economies (including China which turned in 6.9% GDP growth recently). In fact, it would be the first time in history the leading economic indicators (LEI’s) did not roll over and provide ample warning.

The drop in oil prices is the more surprising area of concern by the markets (oil closed at $26.72 per barrel today). It is almost axiomatic that lower oil prices are stimulative for the economy.

If a recession is coming, it would also be the first time in history it was preceded by a crash in oil prices—more often than not, it’s a surge in oil prices which helps trigger a recession. As a consumption-oriented economy, US growth is ostensibly helped by lower energy prices. The rub of course, is that there are segments of the economy which are severely damaged; i.e., the energy and basic materials sectors. What we’re facing now is an environment where the headwinds associated with weak oil have a higher miles-per-hour than the tailwinds, which have yet to pick up. (Source Liz Ann Sounders, Charles Schwab & Co.)

The decline in oil prices has had a dramatic effect on domestic producers, and the consequence has been an erosion of earnings from that sector.  Oil producers, in previous years, would add roughly $3.50 of quarterly earnings to the S&P 500 total (which is now estimated to come in around $29). For the last year oil producers’ quarterly earnings have virtually disappeared. Under normal circumstances, we might have expected around $32 in earnings for the quarter (or around $128 annualized or a 14.2 P/E ratio).   The result is the markets were a bit pricey with more than 10% erosion in overall earnings, and they needed to retrench to reflect this new valuation.

Our approach is tied to monitoring the economic indicators to tell us how we should be positioned.  Right now, those indicators are telling us that we are having a normal market correction driven by a number of circumstances which are not indicating a recession.

“In the short run, listen to the economy; don’t listen to the stock market,” he said. “These moves in the market are like a tale told by an idiot: full of sound and fury, signaling nothing.” (Source CNBC interview of Jack Bogle).

So where does that leave us? We remain confident that equities are the best and only option for long-term investors. In this slow-growth environment, the markets will have continued volatility which can be quite exacerbating.

The reality is we don’t know where the market goes from here. But although we can’t control the direction of the market, we can control what we do about it. We are long known for espousing that panic is not an investment strategy, and that a disciplined approach to asset allocation- involving diversification and periodic rebalancing—are the keys to long-term success. (Source Liz Ann Sounders, Charles Schwab & Co.)

Based on the above, we are not making any changes to our current allocations. We are rebalancing the portfolios through this correction, which is a disciplined process where we will buy those asset classes that are down while selling those that are up. We are closely monitoring the economic indicators for signs of a recession and reviewing our allocations for modification if warranted.

We hope you find this summary useful and please feel free to contact us if you have questions or concerns on the nature of your portfolio. As always, we appreciate your business and continued confidence.