Market volatility has continued today, with markets opening in correction territory, only to rebound somewhat as of midday. Global equity markets have been under significant selling pressure over the past week. The volatility catalyst is tied to the recent moves China made to let their currency depreciate.
Within the span of the past several months we have seen three major global capital market regime changes: the breakdown of the 40-year old OPEC oil cartel and a downward spiral in crude prices; a generational shift in the Chinese economy from fixed asset spending to a consumer driven model; and Lastly, on the horizon we face the change from the US Federal Reserve’s zero interest rate policy to a tightening bias not seen in seven years.
That said, outside the energy sector earnings for the S&P 500 companies grew approximately 4% for the most recent quarter on a year-over-year basis. Not stellar, but hardly recessionary.
What are the reasons to believe this is more likely a temporary pause in the current bull market?
In the United States the consumer remains healthy. The labour market continues to improve and wages are growing. US housing starts rose in July, a seven year high yet still 20% below the long term average. Housing has lagged household formation and there is catching up to do.
While it is difficult to assess the magnitude of any period of panic selling in equity markets given that the performance variance of these events is so wide through time, the duration for this bout of weakness is likely to be measured in days or weeks…not in quarters or years. The near 15% sell-off in 2010 and close to 18% sell-off in 2011 were incredibly uncomfortable, but they did not mark the beginning of the end of the bull market. Keep in mind that the S&P 500 has experienced, on average, an intra-year drop of 14.2% over the past 35-40 years and we have had many positive longer-term outcomes.
The deepest, longest and thus most destructive equity market sell-offs have typically been associated with economic contraction. Currently, we believe the odds of a global recession remains rather low. European, Japanese and American leading economic data continue to point to either healthy or accelerating activity over the next 9-12 months. This should ultimately translate into a better tone to earnings and help to place a higher floor under share prices. It is times just like these when it becomes incredibly important not to give into emotion, but to follow your well thought out and pre-defined investment program.
Like I wrote to a client today. Please do not worry. In our investing years we will go through a lot of volatility. Unfortunately, reacting would be a mistake. We could sell now and markets could recover more quickly than we thought and you would be left with the lower valuation. It is safer to stay the course and ignore market swings. For every stock sold, there is a buyer at the other end which thinks it is a good time to buy. For the patient investor, it will have proven an excellent investment. The market value of our account is less important that the dividends it generates.
Here is my investing 101 word of wisdom.
Always remember that equity investment returns are closely tied to corporate earnings growth and the price you pay for those earnings. Historically, over the long term corporate earnings have been fairly stable and have grown along with productivity gains and inflation. Stock valuations though are more volatile than earnings since they are influenced by investor sentiment, which swings between optimism and pessimism.
To summarize, be prepared for a period of volatility in the month ahead. Europe is slowing, the Feds will start raising rates and the price of oil is set to stay low for a while. But this should not change anything about the way you invest. Use this period as a time of buying opportunity if you can and enjoy the stability offered through dividends.
Please feel free to call me, Terry or Anthony anytime to review your account or to book a meeting.
Some of the key market highlights outlined above were obtained from RBC, TD, Manulife and Dynamic funds market commentaries.