Let’s start this week’s missive off with a disclosure of sorts – I am not Joe Calhoun. Unlike Joe, I have managed to hold on to my hair over the years although the last week has been challenging in that regard. Joe and his lovely wife, Fay, took an extended weekend off and headed towards Key West (a trip planned long before the recent volatility I might add – Joe). As they say in the business, timing is everything and hopefully they will not be introduced to Tropical Storm Erika on the way home. For now, Joe is most likely lying by the pool with a nice glass of wine – or considering what the market did this week, something stronger – in hand. Anyway, if you clicked on this article expecting to read Joe’s weekly commentary, rest assured he’ll be back next week. (And hopefully so will Margie if I can convince her to write more often – Joe)
Reviewing the past week, the word was volatility in bold red, then black letters. As academician and author Natasha Josefowitz might say,
“We’re still not where we’re going, but we’re not where we were.”
Joe commented last week on a convergence of concerns (not necessarily unexpected), that hit the markets, culminating in a sharp decline the previous Friday (August 21st). Following yet another sharp drop in the Shanghai index and another fall in oil prices to below $40, stocks responded in a significant fashion this past Monday. As Joe warned last week, we experienced strong negative follow through at the open Monday and investors were on a roller coaster ride for the rest of the week. Those who sold into the panic at the open Monday morning were likely ruing the decision by midday and suffering whiplash injuries by the close.
The Dow took a 1,000 point plus nosedive in very early trading with some commentators making comparisons to Black Monday in 1987. I can attest to the fact, from managing portfolios back in 1987 and now, a 6.6% drop does not feel the same as a 22% plunge; this was more like charcoal Monday. That aside, stocks showed remarkable resiliency as buyers came in around noon and pulled the markets back. The last hour of trading saw sellers come in again and the Dow closed the day down 588 points, 3.6% lower. The Standard and Poor’s 500 and the Nasdaq were no better off, closing -3.9% and -3.8% respectively. Alternately, the safety play caught a bid and the ten-year U.S. Treasury yield declined to about 2.01%. Although this was the worst one day decline since August of 2011, when you put it in perspective, after four years of no corrections, it wasn’t that bad.
Tuesday, with China spreading fears of a global economic slowdown and contagion to the world markets, we went on another wild ride, a nice midday gain reversed by the close to another loss. But in a quick reversal on Wednesday and Thursday, we experienced the strongest two day rally since 2008 – with oil prices also rebounding strongly. What changed investors’ perceptions so quickly? Perhaps the thought that overall equity prices were no longer as over-valued – bargain hunting? Perhaps a reminder that the U.S. economy, while not robust, is still plodding along? Although our domestic multinationals do have exposure to China and emerging markets’ economies, about 70% of the S&P 500 earnings are still derived from North America. U.S. economic reports during the week, although backward looking, were predominately positive. Month-over-month for July, Durable Goods Orders increased 2%, new home sales were up 5.4%, jobless claims fell more than expected and surprisingly, the second quarter U.S. GDP number was revised upward substantially to 3.7% from an initial 2.3% reading (although there are some problems with that number – Joe). The economic reports were comforting, confirmation that while the economy could be better, and there are definitely pockets of weakness, the world is not coming to an end.
The volatility we have seen recently is, in all probability, here to stay for awhile, no matter the cause – high frequency trading, a bull market getting “long in the tooth”, uncertainties arising from the Federal Reserve’s inconsistent statements, greater interconnectedness of global markets, the expanded role of exchange traded funds (ETFs), liquidity issues, etc. After a strong six year stock market run, investors have been reminded that equities do not rise in a straight line – we were past due for a pull back. Further, it serves as a reminder, as we have consistently reiterated, of the importance of asset allocation in any portfolio.
Active asset allocation, based on a sound investment process, provides the investor with a sturdy tool to weather stock and bond market gyrations by assessing financial conditions in advance and adjusting portfolios accordingly. During periods of extreme volatility, emotional reactions are typically a hindrance. Recognizing acceptable levels of risk beforehand allows one to keep an even keel and avoid an over-reaction. For those of us who consider ourselves long-term investors and have been mindful of asset allocation, this August has merely been a minor, unpleasant bump (and certainly not the last) in a lengthy road. Now, let’s see what happens next week because we still aren’t where we’re going.
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