Periods of market volatility like the last few trading days are, thankfully, rare and always disconcerting. It is just as hard to call a market bottom after a bout of extreme selling pressure as it is to call a top after an extended period of an upward bias in stocks. Remember, markets over time are a very efficient discounter of future economic activity as they distill the actions of innumerable profit-maximizing participants. You may have heard this described as the market’s “invisible hand”. In the short run however the market can be a highly emotional beast. The price action of recent days appears more emotional than logical. The movement we have seen over time to a market more dominated by high frequency trading (HFT) and algorithms can exacerbate these short term periods.
While we have had a pretty strong rebound over the last couple of days, we would be hesitant to state with confidence that the selling is over. It would seem reasonable, maybe even likely, that a retest of the lows of Monday and Tuesday could happen. Still, we are not of the mind that this is the beginning of an extended decline or a bear market and certainly not a period resembling 2008-2009.
Economic data released this week continues to show the domestic US economy is doing reasonably well. Durable goods were released on Wednesday and came in at 2% vs an expectation of (.4). Excluding the volatile transportation segment the number was +.6% vs an expectation of +.4%. Tuesday reported home sales and price data come out indicating that the recent strength in housing, and the improvement in household formation, is continuing and that housing should remain a positive influence on growth for some time. We also had a second revision to Q2 2015 GDP growth that showed GDP expanding at a 3.7% clip as opposed to the previously reported 2.3% (Q1 GDP was +.6%). On the employment front we had jobless claims fall 6K; the 22nd week in a row below 300K. An improving employment outlook was a big factor behind consumer confidence moving from 91 to 101.5 as well. All of the above would be supportive of an outlook, which we have, for continued positive growth in the US.
Commentary by some Fed governors prior to the start of the annual Jackson Hole summit yesterday and today have indicated a Fed that is aware, obviously, of recent market volatility and events in China. What is not so clear however is the impact these events may have on monetary policy decisions by the Fed. The difficulty comes from the fact that while the markets are moving today, the factors influencing the Fed, lower economic growth or reduced inflation, are at best secondary responses to international events. It is hard to state that slower growth in China will not have any impact on US growth; but to what extent. We have an economy that is roughly 13% export driven and the majority of that is not to China. A larger impact is what we import from China and, on that front; their recent currency devaluation reduces costs to US consumers for goods imported from China. This is not unlike lower oil prices having a mixed economic effect but ultimately, probably more of a positive than a negative.
Lastly, we should remember that the debate over a rate move is not about an actual tightening by the Fed. It is a desire to reduce the current extraordinary level of monetary accommodation. Even after a .25% (25 basis points) move the “real” Fed Funds rate will be negative. Inflation by most any measure, while not at the Fed’s stated target of 2%, is still above 1.5%. The market has, as measured by Fed Funds futures, pushed the timing of the Fed’s increase to at least December and maybe even more likely January of 2016. Time of course will tell but as we have stated before, it is not the timing of the first move so much as the tenor of the changes going forward. I would fully expect the Fed to confirm their willingness to be gradual in their approach and do not be shocked if they do, in fact, act in their September meeting.
From a broader perspective; times like this are why we set investment objectives as a part of our longer term process. This is why we spend time asking about long term goals and objectives and willingness and ability to accept risk. There is no riskless way for us to achieve long term goals and objectives. And while on the subject of risk, the volatility we have seen recently is not outside the range of what we should expect. In fact, the unexpected part of the period we have been in is the lack of declines of this nature. While not mitigating the emotions we have all felt in the recent declines, nothing has happened that would fundamentally alter how we view the portfolio construction and risk management part of our process. We always approach the markets with an eye towards risk management. The Asset Allocation Committee will meet in the next 3 weeks to give a more complete update on our thoughts across the economy, Fed policy, and fixed income, equity, and alternative asset classes.
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