Last week’s worldwide market collapse was nothing short of spectacular, with waves of panicked participants selling en masse following the lead from earlier trading time zones in the east. All three US stock indexes ended significantly lower, with the Dow off -7.6%, the S&P 500 -4.3%, and the NASDAQ -0.6% YTD. The MSCI All Country World Index, meanwhile, is now -3.6% YTD . Here’s a summary of why we think the breakdown occurred, and what we’re thinking regarding investments ahead:
A Global Reality Check: There’s absolutely no doubt that the world economy warrants significant caution in the short term. European and Japanese growth has been slower than expected, at 0.3% and -0.4% respectively last quarter – even after currency depreciation, fiscal efforts and stimulus measures. China’s market collapse and slowing growth has shaken the faith of many, and given its global growth contribution over the past 20 years, nations ranging from Brazil and Thailand to Australia are now suffering due to the slowdown in commodity consumption. Alongside, oil’s supply glut has completely upturned regions and sectors; YoY, WTI crude is down over 33%, and essentially at recession levels seen in 2009. As a result, Middle Eastern markets including Saudi Arabia have joined Malaysia, Nigeria, Russia, and other oil-dependent nations, down over 20% from previous peaks. India, which was a bright spot among emerging markets last year due to its service orientation, new government and consumption potential has also reversed course, down 4.5% YTD, given that real reforms are yet to occur with major bills stuck in legislative gridlock.
Stateside, the US, with over 50% of the world’s market capitalization, finds itself in the slowest expansion since World War II, with an average GDP growth of 2.2%, ‘more than a half-percentage point worse than the next-weakest expansion of the past 70 years’, according to Barry Ritholtz, one of our favorite macro commentators via BloombergView. To summarize, we find that the lack of economic leadership from any specific nation has been a unique characteristic of today’s markets. Per the WSJ, the IMF is projecting an annual growth of 1.6% for rich countries until 2020, compared to 2.2% from 2001 to 2007; in emerging markets, growth is dropping to 5.2% compared to 6.7% in the earlier span. We believe this is unlikely to change unless major overhauls such as tax reforms, a reduction in commodity dependence for large economies, and an emphasis on education, infrastructure investment, to name a few examples, occur.
Currencies are adding to the uncertainty. China’s yuan devaluation 2 weeks ago has sent trading partners scrambling to remain competitive via their own currency devaluation. As is, the sustained US dollar strength has led to significant depreciation abroad with Fed interest rate hikes expected sometime soon. With further appreciation likely, currency turmoil is only set to grow, with weaker nations potentially struggling to pay for imports, dipping into their dollar reserves, cutting back spending and paying back dollar denominated debt.
At the same time, regardless of how rational market participants may be, the recent market collapse has been significantly emotion-driven, given that few issues above were actually a surprise. As a result, the strongest US and international firms – ones with sturdy cash balances, high growth potential and positive earnings, to name a few traits, have lost as much, if not more, than their weaker peers during the broad sell-off. Take the US, for example. The domestic economy itself stands on a much better platform today, with deleveraged consumers, a housing recovery en route, slowly rising inflation, and a tightening labor market with increasing wage tailwinds. Recent auto sales, at nearly 17.6 million (annualized), remain near 10-year highs, housing costs are increasing, consumer durable orders are showing good signs, and small business optimism remains high. To summarize, we believe that the recent sell-off has been triggered by the reality check that the slowdown in emerging markets is more than hoped for, compounded by currency turmoil.
Amid these trends, we think changing consumer behavior in the US should provide the next wave of upside, with firms that focus on the 3 concepts highlighted in our July 28th column – asset utilization, data analysis, and information transfer – continuing to pave the path. Skeptics would continue to highlight that any recent gains by the S&P 500 had been driven by only a few companies (Facebook, Apple, Netflix, Google, etc). However, we feel the leadership occurred because they, themselves, have been at the forefront of defining the habits of new age consumption. While it remains to be seen where bubbles may exist – both in public and private markets, we’re not seeing any fewer people in line at Starbucks or Chipotle, wearing Under Armor, streaming Netflix, or scrolling Facebook. Long-term investors should buy a stock for the business, and attempt to ignore timing due to the market noise and sentiment that affects day-to-day stock prices. Let the markets play out at the moment as investors take profits and absorb the news, but remember – annual S&P 500 returns have averaged 9.7% historically, including dividends, according to Dimensional Fund Advisors. It doesn’t make sense to fight consumption trends with the US and growing global middle class, and the recent sell-off is providing enticing opportunities for long term investors for both high quality firms across sectors (including financials, technology, and healthcare), as well as broad market ETFs given that the fundamentals remain good for the US economy. A bit more selectivity is necessary in the short term; we’ll be focusing on this next week.
What it means for you: After weeks of partying, a good laundry cleansing is always in order. The markets are experiencing a correction not seen in several years – that too, after the S&P 500 has gained nearly 250% since the recession bottom in 2009. The indicators of 10-year yields and gold prices have not moved nearly as much as the stock markets – meaning amid the massive selling, fear remains relatively contained. Focus on the fundamentals and be prepared to deploy some cash – albeit, very slowly, as the bears decide how much more wreckage to cause on Wall Street this week.
