The volatility did not subside this week as stocks ended lower. Through the close Friday, the Dow lost 3.3%, the S&P fell 3.4%, and the Nasdaq was off 3.0%. Normally gold does well when stocks decline, but instead sold off by 1.1%. Oil saw a lot of movement, closing the week with a 1.8% gain at $46.05 per barrel. The international Brent oil, used to make much of our gas here in the east, added just over $1 to close at $50.99 per barrel.
Source: Google Finance
We could take the same thing we wrote the last two weeks and use it again this week. The volatile market is increasingly focused on the Fed and this week was no exception.
The Fed will be holding a much-anticipated policy meeting later this month and the closer we get, the more anxious the market gets. The topic of the meeting will be whether the economy has improved enough to begin raising interest rates from this historically low level (low interest rates have helped fuel the rise in stocks, so an increase in interest rates will likely send stocks lower).
Therefore, Friday’s employment report was the center of attention this week. We added just 173,000 jobs last month, a very poor number and the second-worst report in 19 months. Alone, this would likely keep the Fed from raising rates and cause stocks to rise.
However, other employment details were positive, causing stocks to fall. The unemployment rate improved to a seven-year best of 5.1%, though the number was more a function of people leaving the labor force than unemployment actually improving (the amount of Americans not working hit 94 million, a record high). Regardless, a 5.1% rate grabs headlines and makes it difficult to support emergency-level stimulus.
These employment reports are but one of many reports the Fed looks at. Lesser-known, but in our eyes far more accurate, is the employment-to-population ratio. Simply, it is the amount of people employed compared to the total population. As you can see in the chart below, employment has a long way to go to reach pre-recession levels. This will give the Fed pause before raising rates, which will be good for the market.
The Fed will be holding a much-anticipated policy meeting later this month and the closer we get, the more anxious the market gets. The topic of the meeting will be whether the economy has improved enough to begin raising interest rates from this historically low level (low interest rates have helped fuel the rise in stocks, so an increase in interest rates will likely send stocks lower).
Therefore, Friday’s employment report was the center of attention this week. We added just 173,000 jobs last month, a very poor number and the second-worst report in 19 months. Alone, this would likely keep the Fed from raising rates and cause stocks to rise.
However, other employment details were positive, causing stocks to fall. The unemployment rate improved to a seven-year best of 5.1%, though the number was more a function of people leaving the labor force than unemployment actually improving (the amount of Americans not working hit 94 million, a record high). Regardless, a 5.1% rate grabs headlines and makes it difficult to support emergency-level stimulus.
These employment reports are but one of many reports the Fed looks at. Lesser-known, but in our eyes far more accurate, is the employment-to-population ratio. Simply, it is the amount of people employed compared to the total population. As you can see in the chart below, employment has a long way to go to reach pre-recession levels. This will give the Fed pause before raising rates, which will be good for the market.
While the employment report dominated headlines, several other economic reports were released and were mostly negative. The strength of the manufacturing sector hit its lowest level in two years and exports contracted. The service sector showed an expansion, though at a weaker level than the previous month. These, too, will give the Fed pause before raising rates.
More stimulus was also the talk in Europe this week. The head of the European Central Bank (or ECB, which is the European version of our Fed) indicated they were open to doing more stimulus in light of weaker economic reports. Stocks moved higher on the news.
With economic growth stagnating despite record amounts of stimulus, we keep wondering why no one questions whether this stimulus is the right prescription in fixing the economy. Japan has done stimulus in one form or another for over 20 years. We’ve done it for six. Europe, too. Yet the economy continues to stagnate.
We discuss this often. Stimulus is not the cure to an ailing economy. It acts as a painkiller that prevents meaningful change from occurring. Until fundamental reforms are made, we see no reason to break out of this economic funk.
We’ll conclude this section with a look at China. They, too, had very poor economic reports this week. However, this wasn’t the most troubling thing we heard out of the country.
With their stock markets plunging, the government has cracked down on people selling stock. It looks like they have begun arresting (or “detaining”) people who have done so. Like, hundreds of people. This includes prominent figures like heads of banks, reporters, and fund managers. It is a scary environment to be in.
The country has made remarkable strides in liberalizing their economy in recent years, attracting massive amounts of new investment. We think this action by the government puts a serious chill on the reforms they have made and is a major setback for the country.
Next Week
Next week looks to be a quiet one for economic data, but that doesn’t mean the markets will be any quieter. We’ll get a report on employment, trade, and inflation at the producer level.
China will have several economic reports out, too, and with the worries about their economy, these reports may receive more attention than usual.
Investment Strategy
It’s not bad to nibble on some of these downturns. However, at present we’re sitting tight as it’s all about the Fed now more than ever. The direction of the market hinges on their stimulus policy and without a clear path forward, it is difficult to tell where the market will move in the short run.
In the longer run, we think some of our long-run fears are being realized with the recent market action. The distortions created in the market by the Fed’s stimulus program will cause large downturns when the stimulus comes off.
Looking at longer term fundamentals, we are concerned over the lack of companies reinvesting their earnings into their business. Money has instead flowed into stock buybacks and dividends, not reinvested back in the company. This signals lower corporate growth down the road.
Bonds continued to be a popular alternative this week as stocks fell, so bond prices rose and yields fell. However, that trend reversed when stocks found support. Prices are still on the high end of the range we have seen, which makes them an expensive hedge at this point. Cash may be a better option and we would avoid longer-term bonds.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, 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 issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
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.
More stimulus was also the talk in Europe this week. The head of the European Central Bank (or ECB, which is the European version of our Fed) indicated they were open to doing more stimulus in light of weaker economic reports. Stocks moved higher on the news.
With economic growth stagnating despite record amounts of stimulus, we keep wondering why no one questions whether this stimulus is the right prescription in fixing the economy. Japan has done stimulus in one form or another for over 20 years. We’ve done it for six. Europe, too. Yet the economy continues to stagnate.
We discuss this often. Stimulus is not the cure to an ailing economy. It acts as a painkiller that prevents meaningful change from occurring. Until fundamental reforms are made, we see no reason to break out of this economic funk.
We’ll conclude this section with a look at China. They, too, had very poor economic reports this week. However, this wasn’t the most troubling thing we heard out of the country.
With their stock markets plunging, the government has cracked down on people selling stock. It looks like they have begun arresting (or “detaining”) people who have done so. Like, hundreds of people. This includes prominent figures like heads of banks, reporters, and fund managers. It is a scary environment to be in.
The country has made remarkable strides in liberalizing their economy in recent years, attracting massive amounts of new investment. We think this action by the government puts a serious chill on the reforms they have made and is a major setback for the country.
Next Week
Next week looks to be a quiet one for economic data, but that doesn’t mean the markets will be any quieter. We’ll get a report on employment, trade, and inflation at the producer level.
China will have several economic reports out, too, and with the worries about their economy, these reports may receive more attention than usual.
Investment Strategy
It’s not bad to nibble on some of these downturns. However, at present we’re sitting tight as it’s all about the Fed now more than ever. The direction of the market hinges on their stimulus policy and without a clear path forward, it is difficult to tell where the market will move in the short run.
In the longer run, we think some of our long-run fears are being realized with the recent market action. The distortions created in the market by the Fed’s stimulus program will cause large downturns when the stimulus comes off.
Looking at longer term fundamentals, we are concerned over the lack of companies reinvesting their earnings into their business. Money has instead flowed into stock buybacks and dividends, not reinvested back in the company. This signals lower corporate growth down the road.
Bonds continued to be a popular alternative this week as stocks fell, so bond prices rose and yields fell. However, that trend reversed when stocks found support. Prices are still on the high end of the range we have seen, which makes them an expensive hedge at this point. Cash may be a better option and we would avoid longer-term bonds.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, 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 issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
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.
