It’s not out of the ordinary
When stocks are steady or moving higher, the financial headlines don’t pull us in as much as they do when there’s a jarring correction going on. Volatility stirs up a lot of attention in the financial media, but what we’ve been seeing recently is just part of the nature of the market.
Stock market corrections, which are defined as a decline of 10% to 20% of a major index like the S&P 500, are normal. In the context of an expanding economy, they are healthy when valuations get a bit extended; they wipe out excess enthusiasm, reduce valuations, and set the foundation for another round of gains.
Since the May 21 peak in the S&P 500 Index, shares are down 12.35% at their low point in August (St. Louis Federal Reserve). That fits neatly into the definition of a stock market correction.
It’s been four years since shares have lost more than 10% (St. Louis Fed), which is actually an unusually long period: Since WWII, a correction has occurred, on average, about every 20 months.
China’s slowdown and the Fed’s potential rate hikes: Old news
You’ve probably been hearing a lot about both of these in the media. China is the world’s second largest economy and surprised markets by devaluating their currency on August 11 by about 3% (Wall Street Journal). China’s central bank billed the devaluation as a market-oriented reform and a one-time move.
But the timing of the devaluation seemed to coincide with the country’s sagging economy and was widely seen as a way for China to boost exports. With the exception of the devaluation, China’s economy has been slowing for a while. So, it’s old news that should have been priced into shares. (China officially announced that Q2 GDP expanded by 7.0%, according to Bloomberg, but few believe the official report.)
Also, U.S. exports to China make up less than 1% of U.S. GDP (U.S. Census). That’s insignificant. U.S exports to Canada are almost triple those to China (U.S. Census), and our friends to the north have entered a recession (Reuters). Yet no one’s blaming market problems on Canada.
The Federal Reserve is also being blamed for the selloff, but the Fed has been aiming at a possible September rate hike for months. So, like China, this is an old story.
So if it’s not China and the Fed, what is it?
What I believe we may be seeing:
• A middle-aged bull market in its seventh year that hadn’t seen a correction in four years.
• Market internals that have been deteriorating, including a narrowing in leadership. This compares to 2013, when we were witnessing a broad-based advance.
• Pricier valuations, which can add to anxieties.
• Earnings growth that has slowed, thanks to weakness in energy companies and the stronger dollar.
While weak market internals are not always a signal of an impending selloff, China and the Fed provide the perfect excuse for short-term traders to sell.
Looking ahead and short-term risks
More negative news from China may add to the recent volatility. The Fed could hike rates at its upcoming meeting on September 17, but it has consistently telegraphed that any series of rates hikes will likely be gradual. The 1994 and the 2004 rate hike cycles did not spell the end of the bull market. I don’t believe this one will either.
I believe it is the emotions that are associated with heightened uncertainty that have exacerbated the market’s decline.
If you are a number of years from retirement, a drop in the market may provide an opportunity to selectively deploy excess cash.
If you are nearing retirement or retired, your portfolio is adjusted for risk, so it is designed to be less volatile in both up and down markets.
The swift correction may be disconcerting for some, but markets will correct from time to time. Patience is the key, but if selloff has created anxious evenings, we can revisit.
The fundamentals at home have been the traditional drivers of U.S. stocks over the medium and longer term. Currently they are favorable, and I believe they will reassert themselves when the dust settles.
I trust that you have found this summary beneficial and educational. As your financial advisor, it is my job to partner with you, so if you have any questions about what I’ve conveyed in this message or want to discuss anything else, please feel free to reach out to me.