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August 2015 Market Update

 

Last week’s market volatility offered investors both a wake-up call and a reminder that maintaining a diversified portfolio with a long term view is a sound strategy.

Here are a few reminders, or lessons, from last week’s market performance:

Ø Market corrections, defined as a10% decline from all-time highs, are not unusual and don’t indicate where the market is heading once the dust settles.

Ø Trading on the market highs or lows is virtually impossible.

Ø The reported headline percentage moves of the markets do not accurately portray the effect on your wealth.  Case in point, after two days of losses, the S&P 500 gained 3.9% on Aug. 26, but closed at the level first reached on June 20, 2014 when it hit an all–time high of 1,962.  By week’s end, Aug. 28, the S&P was still about 6.7% off the all-time high of 2,130 (close) set in late May of this year.  So if you bought into the S&P 500 three months ago, you have less money.  If you’ve been invested longer you have more money than when you started (just not as much).

Ø Stock markets tend to overshoot good fundamental news and overshoot bad fundamental news.

Ø Economic fundamentals drive stock prices in the long term as equity markets are a leading economic indicator.

So, where are we today?  Prior to last week, U.S. markets had not entered correction territory for over three years.  Our view is that the market overshot bad economic news from China.  However, there is no offsetting good fundamental news to give the market a catalyst for continued, sustained price growth.  So we expect a relatively flat, range bound market for the near term.  Like a plane driven lower in altitude by a storm or high wind, the market should regain altitude but will fly level until it breaks out on either good or bad news. 

Economic fundamentals give us some insight into our current trajectory.  The GDP number for the second quarter was revised upward, but due in large part to increases in inventory.  Stockpiled inventories may dampen future production in the short term as companies adjust for current and expected future demand. 

The market volatility may convince the Fed to delay increasing the Fed Funds rate.  That may have a temporary, positive impact on stocks but not a significant impact since markets already factored in the increase.  Either way, the impact will be small and we don’t expect the Fed to increase rates rapidly or increase rates to their historic levels of around 4%.

Initial jobless claims are at an all-time low but so is wage growth and the labor participation rate. These factors may dampen inflation and allow companies to increase workforce while maintaining profit margins.  It will not be as positive for consumers who comprise 70% of our economy.

Inflation is still not an issue but the possibility of deflation is back on the radar for the Fed.  The CPI all item index increased .2% for the past 12 months.  The index for all items less food and energy climbed 1.8%, still below the Fed’s target of 2%.  The inflation numbers don’t preclude a Fed rate increase but they will slow down the rate of increase, if any.

As we evaluate investments, income generation is a key component.  The ability of companies to pay dividends is based on their ability to generate and grow profits.  Alongside profitability we consider the business and market risks.  The market had a steep decline in price but not necessarily a decline in value.  Warren Buffett teaches “price is what you pay, value is what you get”.  

Call us if you have any questions or concerns.

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