2015 Third Quarter
If you were wondering what precipitated the stock market drop during the third quarter, I believe you can point to China - specifically their rollercoaster stock market ride and the Chinese government's devaluation of their currency, the yuan, in the middle of August. Because investors are at the mercy of whatever economic numbers the Chinese government wants to divulge, no one really knows what is going on inside the world's second largest economy. We knew their stock market was crashing this summer, but investors figured it was due to overvaluation of the underlying stocks and an economic slowdown. Investors were picturing a "soft" economic landing - not a "hard" one. Anytime a government devalues or weakens their own currency, you know that it is a drastic measure...something you would do as a last resort. After all, it will now take more yuan to purchase a dollar and more yuan to purchase foreign goods and services which will hurt Chinese consumers. However, it can also mean that Chinese goods and services are cheaper to the rest of the world. That is exactly China's intention: Boost their economy by making their goods and services cheaper in the eyes of the global consumer.
U.S. stocks dropped not because of weakness with our economy or not necessarily because of earnings disappointments, rather they dropped due to the perception that the Chinese slowdown would eventually overwhelm the U.S. economy and create a global recession. Everything I have read has placed a very low probability on a U.S. recession occurring at this point in time. After all, the Chinese are responsible for less than 1% of the U.S. GDP. Should the Chinese consumer completely abandon any U.S. purchases, their impact on our economy would be miniscule.
The Federal Reserve is going to raise interest rates at some point later this year or early next year. We cannot stay at zero interest rates forever and the Fed will eventually need some ammunition to fight future economic crises (higher rates will give them the option to decrease rates to help in future economic crises). Normally when unemployment rates are this low, we start to see increases in wages. We have not seen that part of it yet, but once we do the thought is that inflation will be riding right along with it. The Fed has a 2% target for inflation...we are about half that right now.
The volatility we have experienced so far this year is not extraordinary. In fact, it is very normal - if not healthy - to be going through these gyrations especially during a six-year bull market. As long as the Chinese slowdown doesn't severely impact the rest of the world and as long as the U.S. economy continues doing well with low unemployment, low inflation, historically low interest rates and positive GDP growth, I still feel very confident that stocks will be the asset class of choice over the next several years. Moreover, it does not hurt to have the current S&P 500 average P/E ratio at 16.01 times 2016 estimates, which is slightly above the historical average.
So my bottom line advice is pretty consistent with what you have heard from me in the past during turbulent times: Hang in there! If you are absolutely not sleeping due to the latest value on your Schwab statement, please contact me. Maybe we could lower your risk level. If you are still working and contributing to a 401(k), this is what you want: You are purchasing stocks at a discount in the hopes that the stock market will be higher upon your retirement than where it is right now. Also, if you have cash sitting on the sideline, now might be as good a time as we have had in the past couple of years to put that money to work. Give me a call to discuss any of these situations. I would be happy to hear from you.