August Turmoil Highlights Eventful 3rd Quarter

As we highlighted in our Special Market Commentary (dated August 25), a concentration of concerning trends came to a head in late August. Fears over slowing global growth, commodity prices, and a US rate hike provided the main ingredients for an unprecedented period of volatility. This was, arguably, sparked by the devaluation of the Chinese Yuan as Chinese economic officials made moves to address their own fears about their slowing economy.  The second half of the quarter proved to be much less volatile. Nevertheless, equity prices and other risk assets remained under pressure.

 A few key issues are still relevant to how the market may react through the end of the year:

  • Risk assets such as stocks, corporate bonds and high yield bonds remain the most likely to be under pressure in the event of another broad based sell off. Safer asset classes such as municipal bonds, US treasuries and cash proved to be a “safe-haven” in the recent sell off.
  • Despite strong statements from Federal Reserve officials, the federal funds rate was kept at zero during the Federal Open Market Committee meetings in September. The market reacted with a short period of volatility as most were expecting the long wait for a rate increase to finally be over. The next FOMC meeting is scheduled for October 27-28.
  • Despite recent volatility, we are still confident a recession is unlikely. There are a few key reasons for this:
  • Recent risk asset sell offs have seen prices pull back into a valuation area that is no longer overpriced and, in some areas, actually undervalued.
  • US Economic data has continued to be mostly positive. Unemployment, currently at 5.1%, is at a seven-year low. Housing starts are at an eight-year high. These are two key factors in economic areas that are historically good indicators of economic health.
  • Bull markets typically end because of an overheating of the economy; not age. To this point, inflation has been virtually non-existent. This is a good sign that the economy is not facing any immediate risk of causing increased prices and overall inflationary effects.

If you have thoughts or questions that we can address, please be sure to let us know. We hope you enjoy the changing weather and the upcoming holiday season.

All Eyes on the Fed

The first quarter of 2015 saw a few key factors dominate the equity and fixed income markets. Earnings began to show signs of weakness as oil prices remained lower and the US Dollar continued to strengthen. Low oil has hurt companies connected to the energy sector while the strong dollar has hurt US companies that conduct business (sell products or services) overseas. However, what has hurt company earnings has been good for the US consumer. Low oil prices have kept prices low at the pump while a strong Dollar has given Americans buying power they haven’t seen in decades.

While market observers have paid close attention to oil price and the Dollar, the central focus has actually been the Federal Reserve. Speculation has been made on when and how dramatically the Fed will raise interest rates. This action is usually taken to combat an economy that is heating up too much or too quickly and to offset any inflation as a result of an improving economy. Many have suggested that the bull market that has run for over six years has been largely supported by historically low rates. As a result, in every recent instance where investors speculated that rates would rise, the stock market declined sharply. It’s a classic example of emotion dictating trading decisions instead of fundamentals. Another way to think of the irrational behavior of the market is this: the stock market is throwing a fit because the Federal Reserve thinks the economy has improved to a sufficient level as to raise rates.

Looking forward to the rest of the year, we feel that the current bull market still has room to run. Headwinds are starting to pick up and volatility will likely continue, but our long term outlook on equity performance is still optimistic. The Fed will likely raise rates this year although we maintain that it will be later in the year and more gradual than the market has speculated thus far.

 From a diversification standpoint, we have been encouraged by the strong performance of international stocks since the beginning of the year. By most broad market measures, international stocks have outpaced US large company stocks by four times year to date. We remain committed to a certain level of global diversification as valuations of overseas stocks remain more attractive the US stocks.

Lastly, we encourage you to have a conversation with us if you have any questions or thoughts on your strategy and financial plan. As always, our primary goal is to serve as your advocate in your progress towards financial success.

The Dilemma of Cheap Oil

What’s been good news for Main Street has added increased volatility to Wall Street as lower oil has proved to be quite
the dilemma. WTI (West Texas Intermediate) Crude has experienced a free fall since mid-Summer moving from over $100 per barrel to under $50. Gas prices have followed suit giving the American household a boost to their bottom line. Nevertheless, the energy sector is a key factor in the US economy and equity markets worldwide have been spooked by the lower price of oil. As oil has dropped, many companies in the sector have seen their profitability plummet. Some think the lower demand for oil speaks to a larger issue of slowing economic growth. This has caused many shareholders and investors to move out of stocks and into the safety of bonds. 

Using a longer term outlook, we feel this paradox of low oil prices will prove to be a temporary market trend. There are
a few reasons for this:

  • Many companies and sectors will benefit from lower oil costs. Everything from auto sales and airline profits, to shipping and consumer spending will be positively impacted. 
  • The US economy has continued to add jobs seeing the unemployment rate fall to 5.6%. 
  • The value of the Dollar has continued to strengthen; attracting capital from around the globe. This has also helped hold down inflation while increasing purchasing power for consumers and businesses. 
  • The combined effect of lower energy costs with a strong dollar is exactly the supply-side growth mix that sparked booms in the 1960’s, 80’s and 90’s. 

As we look forward to 2015 we are focused on a trend that saw US stocks fare better than their international counterparts last year. In 2014 US equities (Russell 3000 Index) increased by 12.36% while international stocks (MSCI EAFE Index) decreased by 6.20%. While international stocks (particularly those in Europe and Japan) suffered modest losses in 2014, we still feel that they are an important part of our asset allocation models moving forward. Valuations of these equites are a depressed compared to the US and bullish influences such as monetary stimulus in Europe look to be a likelihood this year. While US equities still look attractive, given the relative strength of the US economy, the potential economic stimulus in Europe and low valuations of international stocks suggests a balanced level of region exposure is still most appropriate. 

As always, we encourage any thoughts, questions, or concerns you may have. We look forward to talking again soon and wish you a safe and Happy New Year.