Stock Market Correction 2015

Dear Clients,

When the Capital Markets around the world become extremely volatile, it is only natural to feel nervous or down right fearful about your investments.  If you are feeling this way, please don’t hesitate to call or email me.  I would be more than happy to review your portfolio with you and discuss our outlook and plan for your portfolio.

STOCK MARKET CORRECTION?

From everything that I have read, listened to, and discussed with colleagues and fellow industry pros; We are currently experiencing a standard stock market correction.  As most of you know, the US stock market is in the midst of a Secular Bull Market that began in March of 2009.  Since it began, the S&P 500 Index has moved from approximately 667 to a recent closing high of 2,126 on May 18th, 2015.  During this six-year rise in equity prices, there have been several corrections.  From May 2nd through October 3rd of 2011, the market corrected approximately 21% from it’s high.  The next correction occurred between April 2 and June 4th of 2012.  This correction saw the market drop by almost 11% in a matter of two months.  Following this second correction, the market went on a little more than a 2 year up move that only saw a couple 5% pull backs in that time frame.  This was primarily due to the quantitative easing program of the US Federal Reserve Bank.  Eventually the QE party ended and the market decided to correct one more time beginning on September 19th, 2014.  A very fast correction that saw the market drop about 10% in just four weeks.  We are now about three months into a correction that has seen the S&P drop from 2,134 on May 18th of this year to a recent low of about 1820 – a 15% pull back in the major average.

A chart of the S&P 500 Index (from 2009 to Present)

In each of the 3 previous corrections that we have seen during this Bull Market, there were “reasons” cited as to why these corrections occurred; However, in each instance, none of the doomsday scenarios being hypothesized came to pass.  No, in the end, company earnings continued to rise and the true value of these businesses were realized at much higher values.

COULD THIS BE THE BEGINNING OF A NEW BEAR MARKET & THE START OF A RECESSION?

In my opinion, this is NOT the beginning of a new Bear Market.  When I look at all of the data:  Interest rates near all time lows, the Fed contemplating a raise in rates, durable goods orders continuing to rise, consumer sentiment on the rise, and commodity prices at 6 year lows; this data backdrop is not signaling a looming recession.

WHAT ABOUT CHINA?

The Chinese economy is in the midst of a multi-year move from being a strictly export driven economy to more a consumer based economy (this will take many years to happen).  As this change occurs, the GDP of China will flow, ebb, and flow again.  China has moved from a double digit growth economy to about a 6-8% growth economy.  This rate of change is causing many businesses and countries that do a lot of business with China to slow as well.  The good news is that the US does NOT export a lot to China.  US exports to China only make up about 3 to 4% of our total US GDP.  Therefore, the US economy will not be greatly effected by a slowing of China’s economy.

THEN WHY THE CORRECTION?

I will offer you three reasons for the correction:

1)  Anticipation of a coming rate hike (possibly in September) had primed many investors  and short-sellers to begin selling as the market moved above 2100 on the S&P.  Each time the market moved above this level it was sold off.  This began happening back in February of this year.  From a technical perspective, the market was beginning to look “toppy” and ready for a correction.

2) Fear of a debt/currency event in Greece and the Eurozone had moved many investors to the sidelines beginning in March of this year.  Even though the Greek debt situation seems to be abating, many investors were positioned for a crisis.

3) Fear of a severe slow-down in China.  The recent (surprise) move by the People’s Bank of China to cut interest rates further and devalue their currency vs. the Dollar by about 6% signaled to many investors that China was reacting to a major slow-down in its economy.

FINAL CONCLUSIONS – Valuations, Capital Flows, and Interest Rate Rise

Whether it be a slow-down in China, a technical correction based on psychology, or anticipation of an interest rate hike;  I am not compelled to sell stocks out of concern for a Bear Market or Recession.  On the contrary, the fundamental fair value of stocks in our clients portfolios are very attractive at this time.  On a fundamental basis, we see outstanding upside in each these businesses over the next three to five years.  In addition, the majority of our holdings pay dividends with most portfolios producing an average yield between 3 and 5% depending on the holdings.

Furthermore, capital flows should tend to favor stocks over bonds in the next 18 to 24 months.  In my opinion, bonds will begin to lose value due to the rise in interest rates, and a Secular Bear Market will begin for the bond market – causing some of the current $4.5 Trillion currently invested in bond funds to flow out of the bond market and into equity funds.

Finally, a rise of interest rates due to an improving economy should prove to stimulate (not slow our economy).  This is contrary to the consensus theory that rising interest rates help to slow down an economy when inflationary pressure abounds.  Under a “normalized” interest rate scenario, I would not disagree with the consensus; however, US interest rates are at zero and are being kept low as if the US economy were in recession.  In my opinion, the transition from a zero Fed Funds rate to a more normalized rate over the next 3 years will actually act as a catalyst to increase the velocity of money and investment.

As many of you know, it is my goal to always place your capital where it will be treated well.  At this time, high quality stocks that pay dividends offer the best risk/reward treatment of an investor’s capital in my opinion.

As we make it through this 4th correction in the last six years, I expect that we will continue to meet our clients growth and income needs,  and as always, try and offer our Signature Service in helping you plan for the future.

Sincerely,

Patrick Collar