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Key Points
- Concerns about China’s economic slowdown and the timing of Fed rate increases have caused global stock markets to decline this week
- US and European economic data continues to forecast slow growth and few, if any, signs of recession
- We are in a seasonally weak period for stock markets and are likely experiencing late-expansion-stage correction
- Opportunities to increase equity exposure may appear in the next six to eight weeks
The first significant correction in the US stock market since 2011 is underway. We want to provide a brief analysis and ideas on strategy. The S&P 500 has fallen more than 3% during the last three days, including a 2.11% decline yesterday (Thursday) and is likely to fall further today. The Dow Industrials hit its lowest level since October. Markets in Europe and Asia have also declined significantly. Although some sort of reflexive rebound next week would not be surprising, the intermediate term trend is still downward.
Worries about the health of China’s economy and uncertainty about the timing of the Fed’s rate hike has rattled investors. An early gauge of China’s economic activity fell to a six-and-a-half year low in August. China’s unexpected devaluation of its currency caught markets by surprise, producing concerns that China’s economy is weaker than officially reported and fueling speculation that a slowdown in China could spill over to other parts of the world. The decline in oil, industrial metals, and other commodities suggests the rout in stock markets may not be over.
We believe this is a correction and not the beginning of a new bear market. Although economic growth in the US is tepid, it is still positive. Central banks around the world—including the European Central Bank, the Bank of Japan, and the People’s Bank of China continue to pump money into the global economy. This quantitative easing should support prices. Although corporate earnings in the US have been flat, economic indicators are not showing signs of an imminent recession.
Economic indicators suggest that the US economy is in a period of slow growth, but not recession. The US housing market is strong; manufacturing continues to grow, with both the Institute for Supply Management and Markit surveys remaining expansionary.
The services sector has accelerated sharply in recent months and is showing levels not seen since 2005. Future order components of economic surveys are also positive. The auto industry is reporting record sales and consumer confidence is high. Unemployment continues to trend downward, with 215,000 jobs being added in July and unemployment dropping to 5.3%.
So with a solid, but not stellar, economic backdrop, we believe this pullback is most likely normal correction. The first half of this year was marked by the US market trading in an extremely narrow range. Since 1980, the average intra-year decline for the S&P 500 was 14.2%, yet the index still had positive annual returns in 27 of those 35 years. Our point is that pullbacks are more common than recent history suggests and should not be viewed cataclysmically.
As we continue through a seasonally and technically weak season for stocks, markets may lose more ground. Depending on the timing and severity of this correction, a good opportunity to allocate more of one’s portfolio to stocks (buying low) will likely present itself.
Sam Sweitzer, CFA
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