Investor Discussions - Q3 Mid-quarter Update 2 of 2
Wealth & Pension Services Group
Matt B. Bailey, CFA - Portfolio Manager
Since our last update just over two weeks ago, the global stock markets have exhibited volatility not seen since 2011. U.S. and international stocks have fallen significantly from their mid-year peaks. As of Friday's close, the S&P 500 had dropped by around 10% since May. The international markets are down over 15% during the same period. Much of the worry is linked to fears over a slowing Chinese economy and the Federal Reserve’s looming rate decision. Even so, the recent correction has created a more attractive entry point into stocks for long-term investors. We plan to take advantage of this in the coming weeks by reinvesting cash into the market.
Stocks sold off hard over the last few weeks as fears over a slowing Chinese economy and rising rates have spooked investors. Chart 1 illustrates the damage that has been done since our last update. Since then, the markets have seen large daily price swings as investors attempt to reposition their portfolios.
The S&P 500 index finally gave long-term investors the pullback they were looking for as it fell over 10% by the end of August. This is the biggest correction we’ve seen since the summer of 2011 during the first “Greek Debt Crisis”.
Internationally, both developed and emerging market stocks have fallen further than their U.S. counterparts. Nonetheless, many central banks including the European Central Bank (ECB) and Bank of Japan (BOJ) remain highly accommodative. They are determined to do whatever it takes to stimulate economic growth and this could benefit their stock markets.
During our last update, we conveyed our view that the markets were likely to experience weakness in the near term. This thesis has come to fruition but has done so much faster than we anticipated. Although the markets may fall further in the coming weeks, we believe we are close to reaching a bottom. Technical indicators such as price momentum and seasonality suggest the fourth quarter may be kind to stocks. Additionally, the recent pullback has helped fundamental metrics such as forward price-to-earnings and price-to-book appear more attractive. Over the next few weeks, we plan to take advantage of any further weakness in stocks and reinvest existing cash into the markets.
Many areas of the bond market also struggled over the last few weeks. Riskier bonds such as high yield and emerging market debt sold off sharply with equities. U.S. treasuries also experienced weakness and failed to act as a traditional safe-haven asset class. Historically, long-term treasury bonds have garnered assets when stocks selloff and investors seek safety. The lack of demand was likely due to investors bracing for a potential rate hike by the Federal Reserve (treasury bonds tend to be interest rate sensitive and underperform when interest rates increase). It also may be connected to recent selling by the People’s Bank of China (PBOC). They have been reducing their treasury holdings in an attempt to stabilize their currency (this is something new that will require more attention in the coming months).
As we previously mentioned, we think the Fed will likely raise short-term rates this year. This has the potential to negatively impact bonds. With this in mind, we have reduced our bond allocation in favor of cash. Although cash is currently yielding close to zero, it’s relatively more attractive than many areas of the bond market. We see our allocation as a defensive position against rising rates. Be that as it may, we continue to maintain some bond exposure within our portfolios. Bonds provide a steady source of income and a potential volatility buffer during periods of weakness in the stock market.
Although volatility is likely to remain elevated, we think the prospects for stocks look reasonable over the next 12-months. The U.S. economy continues to grind forward, most central banks remain accommodative, and interest rates are at historical lows. These factors have the potential to bode well for stocks, especially at the newly discounted levels.
As always, please feel free to contact us with any questions you may have.
William Kring, CFP®, AIF®
Chief Investment Officer
Matt B. Bailey, CFA®, CMT®
Source: Asbury Research, JP Morgan