The Following is a client letter dated January 20th in light of the recent Market Volatility
World markets have been down sharply since the beginning of the year. Quite frankly, stocks didn’t end 2015 on a very good note either. After the third quarter sell off in 2015, October seemed to show we were back on track, but it didn’t last.
So why is this happening, and what to make of it?
First, I want to point out that while this is the worst start for the U.S. stock market for any year, what is happening is actual a normal market function. Since the middle of the 20th century, markets have experienced a 5-10% sell off in 35% of the years. A 10-20% selloff in 22% of years, and an over 20% decline (bear market territory) at least 18% of the years. Generally, while selloffs can be steep and unnerving, they tend to be followed by even larger and longer bounce backs.
As of this writing, there doesn’t seem to be any panic selling, it has just been a steady slide with a few up days in between. While volatility has increased, it is not at the levels of last summer, and the simple math is that sell orders are just in more abundance than buy orders right now; but that could change at any time. The world economic outlook is still for growth in 2016.
There are many possible contributing factors to the selloff, including:
1.) China’s economy has slowed in the past year. Its official rate of growth slowed to 6.9% in its latest GDP reading. While most analysts believe that China’s official readings always inflated, the consensus is that the Chinese economy was still growing at about 4% at the end of 2015. That is a positive 4%.
2.) In part, China’s market has led to the devaluation of their currency. This shows weakness on their part, and the strengthening dollar means that US exports are more expensive, which could hamper our economic growth here at home. It also causes emerging market debt be more costly to service.
3.) In mid-2014, the price for a barrel of oil was over $100; it traded today under $28. The world is swimming in oil. There has been an energy revolution in the last several years, leading to a supply imbalance around the world.
- The slowdown in China has led to a large decrease in demand for all commodities. Also, the strong dollar (most oil markets trade in US dollars) has had a hand in oil’s lower price.
- The Saudis have increased supply to try and battle US suppliers (it costs much less to drill in Saudi Arabia than the US, so they can withstand lower oil prices for longer).
- Other petroleum producing countries such as Russia, Venezuela, etc. have kept pumping in order to pay for their large social welfare subsidies as oil revenue has declined.
- Many US drillers have taken out loans to expand during the boom, and have continued drilling to try and service all that debt. This has all contributed to much lower prices that are still being squeezed and some bad loans on mid-sized bank books.
- On top of all that, sanctions were lifted on Iran over the weekend, so they are now adding to the oil oversupply, and look to increase exports in the coming weeks. Whether that further increase in supply is priced into the market yet is anybody’s guess.
4.) Most economists agree that it is still unlikely that the US economy is in or near recession, however, the last seven years have continued to be surprisingly weak, including weak 3rd quarter GDP numbers last fall. The Federal Reserve has signaled that their December increase in rates will be followed by more monetary tightening this year. It is quite possible that the Fed may decide to hold off on further increases until things calm down a little.
5.) Even if we don’t have a recession for the whole economy, we definitely had an energy and manufacturing recession over the past year.
Having all these headwinds is a challenge, but the markets also may be oversold right now.
We have seen this many times in the past (see my letter from August 24th, 2015 here), and people who sell right now are only locking in their losses, but we don’t know when the market will turn. Further, with most diversified portfolios being invested in thousands of stocks in many countries and asset classes worldwide, who is to know which stock, country, asset class or currency will stop the slide and turn positive first? Panic selling is about the worst thing that an investor can do. There is an old saying that the definition of a bear market is when stocks return to their rightful owners.
As I have said many times before, your portfolio is built with your long term goals in mind, and we should not react to the swings of markets which we expect to happen from time to time. Making changes to a properly diversified and risk adjusted portfolio should only happen when there are changes in your lifestyle, not when news events happen. As I said, we expect market swings like this to happen, we just never know when or for how long. If stocks were not volatile, we would not expect to be compensated for their risk. It is precisely this added return we expect from stocks that incentivizes us to own them as part of our portfolio; otherwise we would all stay in cash with low or no return.
So, if you are currently taking income from your portfolio, we have constructed enough in reserve in short term high quality conservative assets (such as treasury bills & notes) to weather even long storms, and allow your more risky assets to recover and continue to hedge against inflation for the future.
And if you are still accumulating assets, and aren’t taking income yet, perhaps this is a buying opportunity. At the very least, however, if history is our guide, patience is a prudent strategy.
