Global Glimpse Report

A Market Update

The Dow Jones Industrial average was down 5.8% this past week and is down around 10% from its high in May, and this 10% drop defines what is known as a market correction. It has been almost four years since we experienced a market correction.  Traditionally, there has been a correction at least every 18 months or so.

For perspective, the current bull market was in the third longest streak without a correction in the last 50 years.  So last week’s downturn was the first of its kind in a while, and because of this historical anomaly, it was more shocking than it normally would have been.

We’ve been of the opinion for some time now that the docile markets we’d grown accustomed to for the past year were likely to become more volatile as we got closer to the Federal Reserve’s decision on its well-publicized interest rate hike. For this reason, we’ve been holding more cash than we normally do and have maintained our allocations to select fixed income investments for portfolio stability.  While it’s never fun to watch accounts go down, we believe our clients’ portfolios have held up well under the recent selling pressure.  Allow us to remind you, as a friendly and gentle caveat, that you do not own the market.  What we mean by this is that your holdings are not exactly similar to the Dow Jones 30 or any other benchmark, and do not decline or advance at the same rate as the market.  And when there’s a significant market decline and your holdings decline less than the Dow or other benchmark numbers, you are benefiting from what we like to sometimes call the “downside protection” of asset allocation.

One immediate cause of the last few weeks’ market drop appears to be weak economic data coming out of China. The straw that temporarily broke the camel’s back was a weak Chinese PMI (Purchasing Manufacturer’s Index) reading of 47. Any reading below 50 indicates manufacturing contraction, while a reading above 50 indicates expansion.

We’ve been following China’s well-documented slowdown for some time now and didn’t find the news to be all that shocking.  China’s flailing stock market, sudden devaluation of the yuan, and their rumored lowering of the banking reserve requirements likely snowballed investor perceptions that China’s demand is declining.

China is indeed slowing down and concern is warranted, but we believe that fears are overdone for several reasons. First, China’s stock market isn’t representative of the economy there. The Chinese stock market resembles legalized gambling more than professional investing, and most companies in China are funded with debt instead of equity as in the U.S. Additionally, China’s devaluation of the yuan is a move to make it more market-oriented and not so tightly state controlled, a reason it has heretofore been unable to crack the basket of reserve currencies around the world.

Exports to China from the U.S. make up less than 1% of U.S. exports, meaning U.S. exporters won’t be greatly impacted by the slowdown. Imports from China will actually be even cheaper as a result of the recent currency devaluation, a boost to American businesses and consumers.

In the world of commodities like oil, steel, lumber, copper, etc., China’s loss is America’s gain. All those commodities that China was consuming during its construction boom (almost half of the global commodities supply at the building boom’s peak) are now a whole lot cheaper. Americans filling up their car with gas, building a home, raising a skyscraper, or powering and supplying their factories will all have a little extra spending money as commodity prices fall.  This is another tailwind to the already improving U.S. consumption picture. Conversely, though, these commodity price swings have had negative impact on emerging markets, many of which are major commodities exporters.  But we’ve largely shunned direct investment in emerging markets for some time now precisely for this reason.

Despite the limited exposure to China’s slowdown, the U.S. can’t help but be effected by changes in the world’s second largest economy. We just don’t think these changes will threaten the U.S. economic recovery over the long term.  Interest rates, although still likely to rise in the next six months, are low by anyone’s standards. That will continue to make income producing assets like stocks, real estate, and, to a lesser extent, bonds, look attractive.

There was good news coming from the U.S. last week, largely overshadowed by noise from China.  The U.S. PMI has been strongly in the above-50 expansion range for a few years and continues to look robust. Even Europe, which has been anemic and plagued by problems in Greece, has experienced three months of PMI readings that have been the highest in the last year.

While we can’t control the markets, we can control how we participate in them.  We can choose to own the best businesses available to us at what we believe are attractive prices. We can select the ideal allocation between stocks, bonds, real estate and cash to capture as much of the gains available in the world without giving up protective diversification. Most importantly, we can control our own investment mindset and not let the markets dictate our temperament.

We think a calm, long term outlook is best.  What you own and the long term prospects of those investments are still the most important components of successful investing, and we feel very strongly that we are serving you successfully in this regard.  As always, if we believe conditions are deteriorating dramatically and likely to cause our clients more than temporary investment losses, we will take action. We will continue to be vigilant in the days, months and years ahead to protect your assets to the best of our abilities. We will also continue to invest our own assets right alongside yours, always aligning ourselves with you.

Patrick R. McDowell