Dear Friends, Clients & Colleagues,
Friday was the worst day in the US stock market since 2008 and this week doesn’t look to be any prettier. The S&P 500, the Dow Jones Industrial Average and the Nasdaq are now in negative territory for the year. Could it potentially go down some more? Yes, it could. Should you panic? No, I believe you should not.
China
If you were to ask anyone a month ago what was the greatest risk to the global markets, you may have heard something about Greece or ISIS. Today, it’s all about China.
China has been the engine of growth for the world for sometime now and has been enjoying a GDP growth rate that makes the US and European growth rates of late (around 2%) seem meager at best.
Fueled by demand for cheap labor and cheap products, China has been the factory for the rest of the world, much like Europe was at the beginning of the 20th century and the USA after World War II. Mass production needs raw material, energy and infrastructure, all of which the Chinese have been investing into heavily. With any dramatic growth, there comes speculation, corruption and borrowing. As the tide draws back on China, these weaknesses have become more evident. Exhibit A would the Chinese stock market, which until just recently has defied gravity and been largely supported by the Chinese government. Today the Shanghai Composite closed down 8.5% for the day. This has spilled over to the European markets, which have followed suit and are currently trading down as well.
Believing that they could demand the market to stop going down, the Chinese most likely did more damage than good by putting selling restrictions on the market and by clamping down on outflows of capital. They’ve also tried to demand that Chinese pension funds and companies purchase stocks. This so far has had very little positive effect.
The problem is that China can’t have its cake and eat it too. It can’t open its market and currency to free market valuation (they recently allowed their currency to devalue by nearly 20%) and at the same time control those valuations.
The idea that a new emerging Chinese middle class will come to China’s rescue has not yet materialized. Chinese wealth has led to increased real estate values around the world as capital tries to escape China for safer havens and has allowed other developed nations to enjoy selling products, education and tourism to the Chinese.
China remains the worlds’ second largest economy and the bright side of this situation is that it has tremendous capital reserves at its disposal. They will need to provide much more stimulus to help stabilize the current situation.
US Markets
US domestic stock markets have been trading near their all-time high for a considerable amount of time now, supported by historically low interest rates and strengthening US & European economies.
To add to the fear from a China slow down, US markets have reacted poorly to recent Fed statements at potentially moving towards a rising rate environment.
Falling oil prices may be hurting US oil and gas companies, but they are hurting Russia and the Middle East more so. The US consumer, on the other hand, is enjoying low prices at the gas pump, low inflation and an ever-increasingly strong dollar.
Once again, the United States looks to be the safe haven market for the world.
What to expect
We have taken defensive positions for the time being as there is no telling as to how long or how painful this correction may be, but one thing that I do believe is that this correction will not last forever, and we want to be well positioned for when it stops.
Expect to see more activity from China, which may release more quantitative easing to try and provide a foothold for its market and news from our own Federal Reserve, which I believe will back away from its interest rate rising rhetoric. I’d also expect to see a fair amount of volatility going forward.
As always, we are monitoring the markets and the portfolios closely and will continue to provide periodic updates. In the meantime, please don’t hesitate to reach out with any questions that you may have.
All the best,
Rob
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