Even with multiple positive revisions noting US economic expansion in the second quarter and pegging US 2nd quarter growth at an annual rate of 3.9%, the US stock market could not shake off the global turmoil primarily related to the reported slow-down in China. In addition, The FOMC (Federal Open Market Committee) did not increase short term interest rates despite telegraphing multiple signals that they would be raising and that left investors confused and uncertain on the actual state of the US economy. Today’s disappointing jobs report will only add to that uncertainty with a reported addition of 140,000 jobs, well below the 200,000 consensus estimate. World markets including the US were very volatile during the third quarter. The fourth quarter looks to be more of the same. Today’s Dow tape went from a decline of 260 points to up 200.
US Equity Markets
For the quarter the S&P 500 fell (6.94%), the Dow Jones Industrials dropped (7.57%) and the Nasdaq Composite declined (7.36%). That is the largest percentage falloff since the third quarter 2011. Consumer discretionary (-4.24%), US Staples (-.83%) and utilities 4.45% were the best performing sectors. Energy
(-18.95%) and materials (-17.33%) were the worst performing sectors. The US Broad market declined by (7.26%) during the quarter and is down (-5.39%) year to date. The Russell 2000 (small cap) was the worst performing US equity class posting a quarterly decline of (12.2%).
International Markets
China’s slowdown, weakness in other developing markets, and tepid growth in Japan and Europe lowered demand, and helped send prices for oil and raw materials plummeting. Downward market pressure was exacerbated by the unwinding of a China equity bubble, and an emissions scandal at Volkswagen that spilled over into world equity markets. Stocks slid worldwide with emerging markets bearing the brunt of the sell- off. International developed declined (10.77%) and emerging declined (18.54%) during the quarter.
Gold closed the quarter (4.8%) lower at $1,115.50 and (16%) lower than a year ago. Oil resumed its slide as OPEC ramped up production. Oil began the quarter at $59.47, and dropped abruptly right after the July 4th holiday, ending the quarter 24% lower at $45.09 despite a timely US production decline. It is hard to believe that crude was priced at $91 just a year ago.
Fixed Income Markets
As previously indicated, The Federal Reserve left rates unchanged at their September meeting but again signaled that they would most likely be raising rates by the end of the year. The Fed’s inaction caused the biggest one day yield decline on the two year note since 2010- moving from .811% to .702%. Now capital markets are not forecasting a rate increase until March 2016. The 10 Year Treasury note ended the quarter at 2.06%. The 30 year treasury ended the quarter at 2.86%. Credits spreads widened during the quarter and were affected by mining, and energy industry weakening credit profiles. Yields on treasury’s fell while yields on corporate debt rose amid worries about the US economy and a deluge of bond sales. High yield fared poorly amid the flight to quality. Conversely, municipal bonds rallied.
Based on closing prices, the S&P 500 Index declined 12.35% from its record high on May 21st through August 24th. On average, the US Stock Market has a 10% pullback (defined as a market correction) every 18 months and it had been almost four years since our last one, so based on historical averages, we were overdue. If you look at the 28 times the US Equity market has pulled back by 10% or more over the last 89 years, the average annual return for the next year following is 23.56%. We are in no way predicting the market will be up 20% or more over the next 12 months. Rather, we are illustrating that on average the market is significantly higher a year after a 10% correction. We have had many calls from rightfully concerned clients about reducing their equity exposure once we reached this 10% decline threshold to avoid even further larger losses which unfortunately followed in September.
Our response is simple. Successful market timing is a two-step process and is an exercise in futility. You must first decide correctly when to sell and then determine correctly when to buy back in. In our opinion, by the time you make the all clear assessment, even if you get the first part right, the markets have already adjusted. So in our opinion, avoiding short-term losses runs the risk of avoiding even larger long-term gains. Instead, we recommend waiting until the markets regain previous highs, which they have done in all 28 of the previous market corrections and then deciding if you want to change your allocation. We advise making changes in allocation from a position of strength rather than during a time of panic selling.
Due to a continued weakening in multiple foreign and emerging currencies your 4th quarter equity playbook may include a continued overweighting to US focused companies. US consumer discretionary, telecom, utilities, financials and US small cap fit the bill. Economic data is not indicative of recession at this point. Is the US economy slowing down? Possibly… but it should not be labeled recessionary in any way. Investors seem to be over focused only on macro issues as opposed to the individual merits of specific companies. In the end, corporate earnings drive stock prices. Without question energy and materials company’s earnings have come under pressure due to the sharp drop in the price of oil combined with weaker global currencies. We do want to suggest however that it appears as though the rest of the market’s sectors are being unfairly ignored.
Respectfully submitted,