I was asked on a call this morning if I was thinking about jumping out my window due to the market turmoil. The question was tongue-in-cheek but it got me thinking and and ultimately I did make the jump. After the two-foot drop into the flower bed I realized I preferred to be back in the office and stepped back in through the window. Moving on...
Investors have been unnerved by the economic pullback in China. Among other things China has seen poor manufacturing data, weak auto sales and a plummeting stock market. The U.S. market sell-off has been a response to the bad news out of China as well as the major declines in other Emerging Market stocks and currencies. I would not categorize what we have seen as an Emerging Market crisis just yet but it is possible that if currency declines continue it would be a real challenge for developed markets(read: U.S, Europe, Japan).
Here are some stats that illustrate how challenging recent market action has been:
- The S&P 500: Down 11.3% from mid-July, its first decline of 10% since 2011
- The Dow: Down 13.1% from May, its first decline of 10% since 2011
- Apple: A stock that has been a favorite for retail investors and hedge funds is now down over 23% from it's high in mid-July
- Chinese stocks (Shanghai): Down 38% from June
- German stocks (Dax): Stocks in Europe's strongest country are down 22% from April
- Oil (WTI): Breaks below $39/barrel after a 5.6% decline today
- Copper: A metal whose price is often viewed as a proxy for global economic growth is down to its lowest level since 2009
- European stocks (Stoxx 600): Down 5.3% today, the worst daily percentage decline since 2008
- Commodities (Bloomberg Index): This commodity index fell to its lowest level since 1999
Despite all of this negativity I have seen investors remain calm. Having said that, there are real questions as to how far this market decline will go. The stock market crashes in 2000 and 2008 were triggered by conditions in the U.S. - the tech stock bubble in 2000 and the financial crisis in 2008. Current market conditions are much stronger than either of these periods. If we look a bit deeper we find that in the summer of 1998 the S&P 500 declined just over 18% in response to the Asian financial crisis. In the summer of 2011 the S&P 500 again fell over 18% in response the financial crisis in Europe. Obviously no one can predict with certainty how much further U.S. stocks will fall but the recent stock market declines appear be closer to a buying opportunity than a time to head for the exits. I do expect volatility to continue for several more weeks and there is potential for further losses. However our indicators are pointing to the idea that this is part of a long-overdue correction here in U.S. stocks, not the beginning of a market crash like 2008.
One more topic- I think it is safe to say monetary policy alone has failed to drive economic growth. Over the past seven years we have seen unprecedented market intervention from central banks around the globe. The central bank intervention has focused on keeping interest rates at historical lows and expanding their balance sheets. As an example, the Federal Reserve has kept interest rates at near zero and expanded its balance sheet to over $4 trillion. The table below shows how U.S. economic growth has consistently fallen short of Fed forecasts during this period of extremely accommodative policies:
We have seen these actions by the Fed repeated by the Bank of Japan, Bank of England and the European Central Bank. Why then has growth continued to be so slow in the U.S. and almost non-existent in Europe and Japan? The answer is that there has been very little pro-growth reform in the past half-decade. In the U.S. excessive regulations have stifled economic growth and crippled many small businesses. Rarely a day goes by where there is not a new rule that must be followed. The U.S. has the highest corporate tax rate in the developed world. In Europe rigid labor markets, high tax rates and excessive regulations have made economic stagnation a way of life.
Diving deeper into this topic is for another day. The takeaway is that this market correction has brought on calls for the Fed to not only delay raising interest rates into 2016 but even some have called for the Fed to launch another quantitative easing program. It is our hope that the Fed will ignore these calls and begin a slow increase in rates either in September or October. In a speech that occurred this afternoon, Atlanta Fed President Dennis Lockhart said that he continues to expect that the Fed will hike rates sometime this year. Lockhart is a voting member of the FOMC.
Stock market volatility is a part of investing and stock market corrections are normal. That said, we will continue to keep a close eye on developments in the coming days.