“Escher’s Relativity”. Licensed under Fair use via Wikipedia – https://en.wikipedia.org/wiki/File:Escher%27s_Relativity.jpg#/media/File:Escher%27s_Relativity.jpg
I have always envisioned my brain as a series of hallways with numerous doors. If I let my mind wander, I feel as though I am ambling through an endless maze, peeking in doors to see what thoughts or ideas await me. There are a few doors that are boarded shut, some that are just dead bolted (if only I could find the key…), and others that are wide open. At times I can feel myself approaching the doors that are boarded shut. Those hallways are always dark and I usually will myself to walk past them. Other times, I manage to find the string for the overhead light and decide it’s time to open Pandora’s Box. The human mind is a complex place to reside, that’s for sure.
When I look at the illustration by MC Escher, I feel as though he has drawn the inner workings of my brain. And over the past couple of months, I have been running circles through this interweb of thoughts trying to decipher what is going on the global markets. These day to day movements are irrational and driven by emotions, not fundamentals. So what has been driving the markets, you may ask. “About nothing and everything all at once;” to quote Billy Joe from Greenday.
The headlines proclaiming this is the worst month since February 2009…I mean May 2011…I mean since some month in 2012. These are fear mongering headlines that really don’t mean anything. We have been a state of near bliss with the S&P 500 since 2011, meaning the volatility has been minimal and the returns have been positive. That was la-la land. This past month, while unpleasant, is relatively normal from a statistical standpoint.
The “fear” that the Fed is going to raise rates next month. Really, I’m tired of this headline already. And let’s be realistic, a .25% increase in interest rates is not going to shut down the economy and crash the stock market. Some people will disagree with me on this point, but given time after the Fed raises rates, I think the markets will do fine. According to research by JP Morgan Asset Management, they pulled together 50 years of data from the US Treasury and Standard & Poor’s to find a relationship between interest rate movements and stock market returns. What they found was that when the 10 year treasury yield is below 5% (currently 2.186% on September 1, 2015), there is a positive relationship in increasing rates and stock market returns. Meaning they both go up together. But taking it one step further, when you look at specific stock market sectors, some do well when interest rates go up and others typically struggle. The same goes for fixed income. Bottom line: Don’t throw diversification out the window.
The headlines about the “pros” that called the market sell off. I’m sorry, but these are the same people that have been calling for the US to collapse since 2009 and they’ve been very wrong. A stock market correction is not the end of civilization as we know it. Don’t invest in that doomsday shelter…yet.
A strong US dollar, a slowing growth rate in China, and falling energy prices. These three headlines do warrant attention and further understanding. A strong US dollar can create a headwind on US earnings reports for companies that have revenues from foreign countries. Seeing that 40% of the revenues of the S&P 500 countries come from outside the US, the drag on earnings could be (and has been) impactful in a negative way. But, look a little closer. Let’s use this hypothetical to illustrate the point.
1 Euro = $1.30 USD on September 1, 2014
1 Euro = $1.12 USD on September 1, 2015
On September 1, 2014 you exported $1,000 of your product to Germany and had to convert the value to Euros, the product would be worth €761. Today, that $1,000 worth of product in terms of Euros would be €891. Sounds good right? No. Not for you as the producer/exporter, because now your product is no longer competitively priced in the local currency where it is selling. However, the converse is true. If you were in Germany and you export goods worth €1,000 to the US in September of last year, it would have been worth $1,313. Fast forward to today, if the exporter was content with receiving the €1,000, the same product could be sold for $1,121, making the goods more competitively priced. The point is that if you are an exporter, you benefit from a devaluing your currency to make your goods more cheaper in the global markets. As I mentioned 40% of the S&P 500 revenues come from outside of the US (Standard & Poors) and I think that the currency exchange rates are going to affect earnings until the dollar weakens, but don’t confuse that with poor sales and revenues.
I can’t even begin to delve into the China situation. Are they importers? Are they exporters? Is their demand for oil weakening? Is their currency going to be a reserve currency? Too much to tackle in this short missive. So here are some very BROAD observations about China. Over the past decade they have been experiencing a shift in their economy from an agrarian (farm) society, to a more urban/suburban economy. As the demographics have shifted to the urban society, so has their spending…they want more “things.” Technology, housing, cars, phones, and the list goes on. But isn’t China the home of cheap labor? Not so much any more. According to the Economist, wages in China have inflated 650% over the past 25 years. The caveat being they were only getting paid pennies in the first place and today the average daily wage earned in a factory is $27.50, so the inflation was well founded in my opinion. The second part of that is the productivity of the Chinese laborer. An American worker can produce as much as 15 Chinese workers, and American wages are actually deflating (Fidelity Investments). Combine that with lower oil, manufacturing has been moving out of China and returning to the US or going to cheaper labor markets. Stir in the fact that their GDP is not growing at the same rate it used to, this I believe could impact the global economy. Does it warrant the massive volatility over the past month? I don’t think so. I think back on how the US has evolved over the past 100 years and to some extent, China is starting to experience a similar shift. It’s definitely not a bad thing, it’s just something that the global economy has to adjust to.
And falling oil prices…yikes. Again, great for the consumer, not so great for oil companies and the S&P 500 Index. There are few things that are impacting the fall in oil prices. Since commodities are priced in dollars, a strong dollar typically means commodity prices will go down (an inverse relationship). Secondly, demand is weak (remember China slowing?) and supply is high (remember the shale revolution in the US and OPEC production mandates?). These lower prices will have a negative impact on the S&P 500 index as oil related companies make up 8% of the index (CNBC).
Have I wandered around the Relativity staircase enough for you yet?
I think the short term will continue to be volatile as we recalibrate. I do not think we are on our way to a bear market and a recession, as fundamentals continue to be strong. In times of market panic and chaos, fundamentals are ignored and emotions take over. Yet again, we had record breaking outflows from equity funds last week. Don’t be average. Stay the course and adjust to the market conditions. It’s not always an easy course and it can be disappointing to see negative returns over a month, quarter, year or even years, but the odds are ever in your favor.
I haven’t swayed from my tenets of being diversified, investing in alternatives, and staying the course. It’s not always going to feel good, but look at these short term dislocations as opportunities. If you had lost all access to news last week (the week of August 24th – 28th, 2015) and got it back on Saturday, you wouldn’t have even known that the markets went haywire in between. We are not seeing the “overs” in the market…spending, borrowing, and confidence…that usually precipitate a recession, so while I understand this volatility is uncomfortable, this too shall pass.
Questions, comments, concerns? I want to hear from you. I want to meet with you and review your plan. Don’t have a plan? Let’s make one today and not wander the hallways aimlessly.
Until next time,
LPL Wealth Advisor
Williamsburg Financial Group
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.
Economic forecasts set forth may not develop as predicted.
All investing involves risk including loss of principal.