A very volatile week saw stocks take a turn lower. For the week, the Dow fell 1.0%, the S&P lost 1.4%, and the Nasdaq fared the worst with a decline of 1.5%. Gold usually does well with market declines, but fell a slight 0.1% on the week. Our domestic oil saw a gain, rising 2.1% to $93.54 per barrel. The international Brent oil, which is used for much of our gas here in the east, neared its lowest price in two years to close at $97.45per barrel.
Source: Yahoo Finance
There wasn’t one single story could blame for the decline in stocks this week. Instead, it was several smaller stories playing a part. There are fears over slowing economic growth in foreign markets, plus a reduction in stimulus by our central bank. This all comes as our stock market becomes increasingly expensive and trades at record highs, making investors nervous.
Several reports released this week pointed to slower economic growth around the globe. Reports on the strength of the manufacturing and service sectors in Europe hit the lowest level of the year, leading many to believe Europe was heading back into recession.
This has prompted traders to speculate whether the European Central Bank (ECB) would take additional stimulus measures. The ECB has already pledged extraordinary measures, but traders are looking for even more extraordinary measures. After all, if the medicine hasn’t worked yet, even more should do the trick, right?
China, too, is facing slower growth worries. The big story is with the slower growth, their central bank does not appear likely to do any more stimulus (again, it’s all about the stimulus). This has investors worried since stocks rise on stimulus. It has even prompted the Chinese government to consider replacing the head of the Chinese central bank, signaling their commitment to additional stimulus to hit growth targets.
Another international story weighing on markets came from Russia. They are debating the seizure of foreign assets in the country, a step that would severely damage not only their economy, but would hurt Europe and the U.S., too. It would also increase tensions further in the region.
Here in the U.S., investors are preparing for the reduction in stimulus from the Fed. Next month they will end their bond buying program, where they print money to buy bonds, pushing down interest rates to spur borrowing.
They will also increase interest rates in 2015, which is certain to weigh on stock prices. The debate is, exactly when will they raise rates? The Fed sent mixed messages this week. One regional Fed president indicated rates could rise in early spring, another they won’t be raised until summer, if not later. This added to the market jitters this week.
All these stories of increases and decreases in stimulus have had a significant impact on the currency markets. Countries who talk about doing more stimulus see their currencies weaken. The U.S., who is pulling back on stimulus, has seen its currency strengthen. It is near two-year highs against the Euro and six-year highs against the Japanese Yen.
We see this as a positive. It reduces prices for commodities like oil and food, leading to lower prices at grocery stores and gas pumps. We think this will be a net positive for our economy.
Finally, economic data this week was mixed, but really had little impact on the market. New home sales showed a very strong gain, but existing home sales showed a decline. GDP for the second quarter was revised higher, while durable goods (which are items with a longer life) showed a sharp drop.
Next Week
Next week looks to be another busy one as the third quarter comes to an end. We will get info on personal income and spending, housing, and the strength of the manufacturing and service sectors.
The most important report will come on Friday with the monthly employment report. Last month saw a terrible number, so investors will be watching for a better number this month and possibly an upward revision to last month. If there is a disappointment here, it is possible the market will rise since the Fed will be less likely to pull back on stimulus of employment is poor.
Investment Strategy
Even with the sell-off this week, our outlook is unchanged. We are cautious for the short-term, though not doing any significant selling at this point. Stocks would need to sell off much further before we did any buying.
Below is an update to one of the charts we’ve been following as a leading indicator. High yield bonds (the black line) has recently served as a good leading indicator for the direction of the broader market (the orange line). Those bonds sold off very strongly this week, indicating a sell-off in stocks is very possible. However, no indicator is perfect. As we’ve seen recently, the market has moved on the words of central bankers. This makes it impossible to time the market when their actions are inherently unpredictable.
Several reports released this week pointed to slower economic growth around the globe. Reports on the strength of the manufacturing and service sectors in Europe hit the lowest level of the year, leading many to believe Europe was heading back into recession.
This has prompted traders to speculate whether the European Central Bank (ECB) would take additional stimulus measures. The ECB has already pledged extraordinary measures, but traders are looking for even more extraordinary measures. After all, if the medicine hasn’t worked yet, even more should do the trick, right?
China, too, is facing slower growth worries. The big story is with the slower growth, their central bank does not appear likely to do any more stimulus (again, it’s all about the stimulus). This has investors worried since stocks rise on stimulus. It has even prompted the Chinese government to consider replacing the head of the Chinese central bank, signaling their commitment to additional stimulus to hit growth targets.
Another international story weighing on markets came from Russia. They are debating the seizure of foreign assets in the country, a step that would severely damage not only their economy, but would hurt Europe and the U.S., too. It would also increase tensions further in the region.
Here in the U.S., investors are preparing for the reduction in stimulus from the Fed. Next month they will end their bond buying program, where they print money to buy bonds, pushing down interest rates to spur borrowing.
They will also increase interest rates in 2015, which is certain to weigh on stock prices. The debate is, exactly when will they raise rates? The Fed sent mixed messages this week. One regional Fed president indicated rates could rise in early spring, another they won’t be raised until summer, if not later. This added to the market jitters this week.
All these stories of increases and decreases in stimulus have had a significant impact on the currency markets. Countries who talk about doing more stimulus see their currencies weaken. The U.S., who is pulling back on stimulus, has seen its currency strengthen. It is near two-year highs against the Euro and six-year highs against the Japanese Yen.
We see this as a positive. It reduces prices for commodities like oil and food, leading to lower prices at grocery stores and gas pumps. We think this will be a net positive for our economy.
Finally, economic data this week was mixed, but really had little impact on the market. New home sales showed a very strong gain, but existing home sales showed a decline. GDP for the second quarter was revised higher, while durable goods (which are items with a longer life) showed a sharp drop.
Next Week
Next week looks to be another busy one as the third quarter comes to an end. We will get info on personal income and spending, housing, and the strength of the manufacturing and service sectors.
The most important report will come on Friday with the monthly employment report. Last month saw a terrible number, so investors will be watching for a better number this month and possibly an upward revision to last month. If there is a disappointment here, it is possible the market will rise since the Fed will be less likely to pull back on stimulus of employment is poor.
Investment Strategy
Even with the sell-off this week, our outlook is unchanged. We are cautious for the short-term, though not doing any significant selling at this point. Stocks would need to sell off much further before we did any buying.
Below is an update to one of the charts we’ve been following as a leading indicator. High yield bonds (the black line) has recently served as a good leading indicator for the direction of the broader market (the orange line). Those bonds sold off very strongly this week, indicating a sell-off in stocks is very possible. However, no indicator is perfect. As we’ve seen recently, the market has moved on the words of central bankers. This makes it impossible to time the market when their actions are inherently unpredictable.
While we are somewhat cautious in the short term, we have serious concerns for the longer run. Stocks and bonds appear overvalued from a longer term perspective, especially as our central bank cuts back on stimulus. Other central banks around the world are picking up the slack, but it is still reason for caution. Europe is a particular worry as they drift back into recession with record levels of overvalued debt. At some point we see this correcting in a painful way, but it is anyone’s guess as to when this will occur.
As for the bond market, bonds rose in price this week (so yields fell) as stocks sold off. A short position has not done well here (where your profit increases when prices fall) and may continue to do poorly if stocks fall further. However, a longer term perspective suggests bonds may fall as central banks increase rates. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities.
Bonds to protect against inflation, or TIPs, have done well on the higher inflation reports. Like the rest of the bond sector, though, they have seen some weakness in the last several weeks. We think they remain an important hedge against future inflation in the longer run. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
As for the bond market, bonds rose in price this week (so yields fell) as stocks sold off. A short position has not done well here (where your profit increases when prices fall) and may continue to do poorly if stocks fall further. However, a longer term perspective suggests bonds may fall as central banks increase rates. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities.
Bonds to protect against inflation, or TIPs, have done well on the higher inflation reports. Like the rest of the bond sector, though, they have seen some weakness in the last several weeks. We think they remain an important hedge against future inflation in the longer run. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
