Wait, wait! What is going on with the market? Facts, observations and thoughts....
- Howard Isaacson
- Jul 28, 2015
- 5 min read
The US stock markets have
moved lower each day, over the past 5 days. There is now a bit of concern, some fear, and talk of a correction. In the paragraphs below, we hope to clarify where the markets are and update you on the US economy. Bottom line – Things are no so bad….
The Dow since the start of July:
As you can see, we are slightly below where we started the month, but not as low as we had been on July 8th. The pull back was from “all time highs” and thus, it does feel a bit different but it really is not any different than typical market volatility.
Below are two charts, with the first being the CBOE Volatility Index over the past 7 days:
The above chart looks a bit problematic, but if we look at the same indicator over the past year, the picture is very different:
Per the chart, we were at similar lows one year ago, then in October volatility skyrocketed, coming back down in November and December, and this year, we have been high and low….. The take-away is that the volatility numbers we are at now were last visited in early July at levels 20+% higher.
Issues earlier in the month and quoted from our Notes from July 10th included:
1. ”Greece and its ramifications on the EU, common currency and other EU members (and their constituent “far right parties”.)” - Greece over the past few weeks has gone through hard times, but the banks have reopened, negotiations are continuing and a Grexit is off the table. Good for the EU, Greece and the world.
2. ”Jihadists affiliated with Al Qaeda and ISIS, and their reign of terror in the Middle East, North Africa and its potential spread.” – No real change here except that Syria, Egypt, the US, Turkey, etc. are all fighting back. Turkey has actually called for a meeting of NATO based on Article 4, which is only invoked when territorial integrity, political independence or security may be threatened. The outcomes could be multinational, which would be a good thing.
3. ”China’s naval infatuation with land reclamation and militarization of islands in the South China Seas.” – Remains and issue and likely will be an issue for a long time…. China has been pacifying the US politically, manufacturing for us and selling to us for years, and lending us money to pay for their goods, all the while they are building a very capable military establishment coupled with very negative words against the US. (Just saying…. But at the same time, the old children’s rhyme is very relevant – “Sticks and stones may break my bones, but names will never hurt me.” )
4. ”The Federal Reserve’s messages and actions regarding interest rate increases.” – They continue to emphasize that their decision to raise the target rate will be based on data, and that they continue to wait on the data. The Fed is meeting this week, and many are hoping that their statement will provide hints regarding a rise in September.
Not on the list from July 10th was mention of the markets in China. The stock markets in China have certainly been volatile. One year ago, the SSE Composite was at 2183. It hit a high of 5166 on June 11th and then lost almost 1500 points over 3 weeks, after which it rose, and most recently (over yesterday evening, July 27) it lost 8.5% overnight. The Chinese market exhibited “bubble” dynamics and the “Greater Fool Theory” as it rose, even though the pace of China’s economic growth was slowing and as China faced significant levels of overcapacity from over building as well as recent factory closings in many areas of its economy.
Certainly, the volatility is troubling in China for those invested in their market, but there is no linkage between the Chinese markets and the US stock exchanges. US valuations were not bolstered as the Chinese markets increased in value and the US markets should not suffer any significant long-term declines from a crashing Chinese market (if, in fact, it is crashing. Maybe it is forming a double bottom, before resuming its climb…. Either way, staying far away from the Chinese indices is likely conservative advice.) Yes, the US markets today attributed their negativism to the Chinese market decline, but as long as growth rates, cash flows and earnings drive stock prices in the US, there should be no extended impact from China’s exchanges.
The US Economy:
As has been noted above and numerous times by Fed. Chair Yellen, the Fed’s raising of the target rate will be driven by data. The data should demonstrate that:
The US economy has enough strength on its own to continue to grow and ideally have accelerating growth.
Inflation is near the target of 2%.
Employment continues to improve and wage growth exceeds inflation, thus demonstrating improved quality of life.
GDP growth is solid, increasing and sustainable.
In a speech last week, St. Louis Fed. President James Bullard indicated that there was more than a 50/50 likelihood of the target rate being increased in September. http://www.arkansasonline.com/news/2015/jul/21/rate-rise-odds-set-by-fed-s-bullard-201/?f=business
The Fed’s own projections released indicate that the average Fed Funds Rate for the 4th Quarter is expected to be 0.35%. http://news.morningstar.com/all/dow-jones/us-markets/201507248620/fed-economic-forecasts-released-early-4th-update.aspx
Durable Goods Orders in June were up 3.4% versus a decline of 2.1% in May, including ex-transportation up 0.8% http://www.morningstar.com/news/dow-jones/TDJNDN_201507275834/us-durable-orders-up-34-in-june.html (Good, not great.)
CPI and Wage Growth:
Slight pickups from prior months in both Hourly Wages and CPI. (Better, but not good.)
New Home Sales in June came in at 482k, versus expectations of 550k and 517k in May (the highest since 2008). June was 18% higher than last years’ June. Prices moved a bit lower and inventory rose to 5.4 months from 4.8 months in the prior month. http://news.investors.com/economy/072415-763262-new-home-sales-down-spanish-unemployment-at-four-year-low.htm (Good, not great.)
The Markit US Manufacturing Purchasing Managers Index was up a bit from the 20 month low it hit in June. Outputs and new business volumes expanded in July, but they noted job creation fell back to figures last seen in April. (Okay, not great.)
The Dallas Fed Survey for July noted that Texas factory activity declined in July, but their production index though negative moderately improved from the prior month. Expectations for the future improved solidly. https://www.dallasfed.org/microsites/research/surveys/tmos/2015/1507/tmos1507.pdf
(Better, though not good.)
Conference Board’s Leading and Lagging Indicators:
(Good!)
Jobless Claims:
Initial claims for unemployment insurance hit lows not seen since November 1973, 255,000! The four week moving average continued lower by 4,000 to 278,500. http://www.dol.gov/ui/data.pdf (Great!)
Corporate Earnings:
Through July 24, 2015, 187 of the 500 S&P 500 companies had reported earnings. Per Factset, 76% beat mid-point earnings estimates and 54% beat on sales. Healthcare, telecoms and industrials have the greatest share of companies beating estimates, with utilities and energy having the lowest percentage of beats. http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_7.24.15
(Okay, not real good.)
Economic Summary:
The economic news is certainly not 100% conclusively positive, but it is far from bad and definitely improving. So, the Fed may or may not push the target rate up in September and there is still much time between now and December….. (As an aside, The International Monetary Fund’s Managing Director Christine Lagarde has gone on record to request that the Fed defer any hikes until 2016, citing the already strong US Dollar, the continuing Quantitative Easing in Europe, and the risk of declining US exports associated with a strong USD.)
Concluding Thoughts:
Based on what we have looked at, including the global environment, the US economy and corporate earnings, there is no reason to strongly believe that the volatility we have experienced over the past few days is anything but typical market volatility. This would include normal pull backs.
It is important to note that it has been four years since our last “correction”, which is defined as a pullback from a recent high of more than 10%. Additionally, this is the second longest bull run without a 10+% correction. Thus, a correction would certainly not be unexpected, and like most corrections, it could establish the starting point for the next bull run.
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