Stock markets across the globe went into selling mode last week, with stocks in the U.S. declining more than 5%.1 European markets saw a slightly higher level of sales. The Shanghai Composite, the major Chinese stock market, sold off more than 11% last week.1 This activity is continuing this morning as we write. The Dow Jones Index opened down nearly 700 points this morning, but then saw several hundred points gained back. It is currently trading down by a few hundred points, with this figure likely to have changed by the time you read this Market Brief. The recent devaluation of Chinese currency and concerns regarding further devaluations are front and center in this sell-off.
However, there is little evidence that the U.S. economy is about to slow, necessitating a large market correction. Additionally, manufacturing activity in Europe and Japan has actually accelerated somewhat in recent months. The economies in the United States, Europe, and Japan will all benefit from lower energy prices. Oil price decreases from $104/barrel in June 2014 to the around $40/barrel price we are seeing currently significantly cuts energy costs for many sectors. Recent data on retail sales and housing have been positive. The Wall Street Journal surveyed economists recently, with the general consensus being an expectation of an upward revision of U.S. 2nd quarter GDP to around 3.3%.2 The Fed had been expected to raise interest rates in September because the U.S. economy has been performing well enough for inflation to begin to be of concern. While this may now be delayed, the general indicators that show a strengthened U.S. economy have not changed.
China accounts for about 15% of the world’s economic output, with an economy heavily based on export activity. While a slowdown will be felt in China, it is unlikely to impact the United States. Exports to China from the United States comprise less than 1% of U.S. GDP.2 Japanese exports to China are greater at 2.7% of their GDP.2 European countries such as Germany, France, Italy, and Spain all have Chinese export figures similar to either the U.S. or Japan. The bottom line for all of these economies is that a contraction in the ability of the Chinese consumer to spend will have little to no effect on the export economy of each country. Countries near China, such as Korea and Vietnam, will likely see more significant effects to their economies from a slowdown in China.
I would remind both retired and near retirement clients that stock market sell-offs do not directly impact the level of income earned from their accounts. Company profits determine dividend levels and other distributions, not stock prices. The Price Earnings (PE) ratio for the S&P 500 is currently about 16.5,3 compared to a 60 year average of around 17. In comparison, the PE of the S&P 500 in early 2000 – just before the market drop – was around 34.
Heavy fixation on the short-term can make it harder to remain focused on longer-term goals. Each time the market has seen significant drops, a client or two has asked me to sell-off significant portions of their portfolio. The plan is always to wait out the drop. Unfortunately, this strategy has never worked. In each case, the client sold at or near a low and waiting to reenter the market at a higher price. This type of selling is emotionally gratifying, but cause real long-term losses. Prudent homeowners do not sell their homes when Zillow dips as they know the value in the property is in the long-term. The prudent stock market investor should view their portfolio from a similar perspective. A well-diversified portfolio and a little patience helps the experienced investor ride out market volatility.
1) Wall Street Journal (weekend), 8/22/2015-8/23/2015, What Investors Shouldn’t Do Now, Jason Zweig
2) Wall Street Journal (weekend), 8/22/2015-8/23/2015, Economic Risk Varies Around the Globe, Greg Ip
3) SPY PE for 8/21/2015 as listed by State Street and WSJ Market Data Center for 8/21/2015