Monthly Economic Update for September, 2015Submitted by Kaizen Financial Advisors, LLC on September 8th, 2015
“All human power is a compound of time and patience.”
– Honore de Balzac
Patience, not market timing, is often far more appropriate when markets take sudden and unanticipated turns in performance.
At a big event, you can bet I'll be sent. Whenever there’s action or a gathered flurry, I'll leave with my crew and I'm off in a hurry. I always try to tell the truth, even from the rain or snow without a roof. What kind of person am I?
Last month’s riddle:
Last month’s answer:
Below are market specifics for the month of August. Before we get there, though, I’d like to take a moment to discuss market volatility. August was a reminder that markets are volatile. Since the market peak on May 21st, the markets have moved into correction territory. This means that they have dropped 10% since this peak, a larger decline than we have experienced since 2012.
This has led a few clients to ask, “What is the difference between a market correction and a bear market?” As mentioned above, a market correction is a 10% drop from a recent peak. A bear market, on the other hand, is when a broad index declines 20% from a recent market peak and when the decline lasts more than two months. Bear markets are triggered when investors lose faith in the market as a whole – decreasing the demand for stocks. Bear markets are hard to predict, but they occur every 3.4 years on average. The last bear market for US stocks ended in March 2009, over 6 years ago, so statistically we are overdue – ugh! Lucky for us, bear markets do not predominate. Although the market rises more than it falls, a falling market is very unpleasant.
So, how do you protect yourself from a bear market? I wish it were easy but here are some different strategies:
Strategy 1: Never ever invest in equities. However, this guaranteed protection has a high cost: You'll never benefit from the gains from bull markets.
Strategy 2: A better way to protect your assets is to diversify among many equity asset classes. This worked very well from 2000 to 2002: While the S&P 500 dropped more than 50%, a diversified equity portfolio fell only about 14%.
Strategy 3: Add bond funds. Over the past 45 years, the worst calendar-year performance for a combination of 40% diversified equities and 60% bonds was a loss of 14.9%, in the devastating year of 2008.
Strategies 2 and 3 have been out of favor recently, but it is a good reminder of how important it is to be diversified in your portfolio. Most importantly, at the end of the day my advice is: Keep your expectations in check, be patient, and take the long view.
See below for market specifics in the month of August.
THE MONTH IN BRIEF
DOMESTIC ECONOMIC HEALTH
Second-quarter GDP turned out to be much better than originally thought. The second estimate of Q2 growth from the Bureau of Economic Analysis came in at 3.7%, way up from the initial 2.3% and topping the 3.1% consensus forecast at Briefing.com. Additionally, capital goods orders rose by 2.0% in July (0.6% minus transportation orders). July also brought a 0.6% rise for industrial output.3,4
Hopefully, some of that increased demand for hard goods will be reflected in the Institute for Supply Management’s upcoming manufacturing PMIs. ISM’s August factory PMI came in 1.6 points lower at 51.1; that was its poorest reading since May 2013. ISM’s service sector index climbed 4.3 points to 60.3 in July, approaching its all-time peak of 62.0 set 18 years earlier.5,6
Some of the August responses to the two most-watched U.S. consumer confidence polls were compiled before the stock market corrected. That factor may partly account for the big leap in the Conference Board’s consumer confidence index, which went from a revised July mark of 91.0 to 101.5. The University of Michigan’s consumer sentiment index (which included responses collected after the record 1,000-point intraday drop of the blue chips) finished August at 91.9, one point underneath its preliminary August reading.4,7
Consumers were spending and buying a little more. July had seen a 0.3% gain for personal spending, with the Commerce Department revising June’s increase to the same percentage. Personal incomes were 0.4% improved in July, matching the rise seen in April, May and June. July’s 0.5% boost in consumer wages was the largest since November. Retail sales rose by 0.6% in July.4,7
Analysts who think the Federal Reserve should postpone a fall interest rate hike often cite negligible consumer inflation. The latest Consumer Price Index certainly supported their argument. In July, the headline and core CPI rose only 0.1%; that put the yearly rise in overall consumer prices at just 0.2% and the annual advance for core consumer prices at 1.8%. The Producer Price Index rose 0.2% for July with the core PPI up 0.3%.4,8
On August 23, former Treasury Secretary Larry Summers published an op-ed piece in the Washington Post cautioning against a September interest rate hike by the Federal Reserve, writing that it would be “a serious error that would threaten all three of the Fed’s major objectives: price stability, full employment and financial stability.” Economists polled by Bloomberg in late August still thought the Fed might make a move this month, even after the stock market’s swoon: 48% saw the central bank doing so. Another 17% felt the Fed would raise interest rates for the first time in nine years in October; 24% thought the move would be made in December.9,10
GLOBAL ECONOMIC HEALTH
Purchasing manager indices gauging manufacturing in other countries were mixed. Japan’s Markit PMI rose to 51.7 in August; India’s was at 52.3. Markit PMIs for South Korea (47.9), Taiwan (46.1), Indonesia (48.4) and Malaysia (47.2) all showed contraction. Markit’s factory PMI for Germany read 53.3 in August, and the overall eurozone Markit manufacturing PMI was at 52.3; Italy’s Markit factory PMI was at 53.8. The European Central Bank is easing to help euro area economies; perhaps this manufacturing sector expansion will hold up in the face of the headwind from Asia. Data showed the eurozone jobless rate declined 0.2% to 10.9% in July.11,12
As for major regional and multinational indices, the Europe Dow fell 7.45%, the STOXX Europe 600 8.47%, the Asia Dow 9.91%, the Dow Jones Americas 6.31%, the Global Dow 7.42%, the MSCI World 6.81%, and the MSCI Emerging Markets 9.20%.1,13
The major news here was oil staging a comeback. Light sweet crude rose 2.97% for the month, reaching an August 31 close of $45.81 on the NYMEX. Unleaded gasoline managed no such gain – futures slipped 10.61% for August. Natural gas lost 0.99% for the month, but heating oil rose 6.37%. Crops had it rough in August, with all of the major ag futures in the red – soybeans fell 8.43%, wheat 2.86%, cocoa 2.68%, coffee 3.89%, cotton 0.42%, sugar 9.94% and corn 2.15%.14
Gold retreated 10.61% for the month, settling at $1,138.90 on the COMEX August 31. Silver lost 1.82% in August, settling at $14.56 at month’s end. Copper futures slipped 0.91%, but platinum futures gained 2.65%. The U.S. Dollar Index was also among the August losers, declining 1.59% for the month to 95.82.14,15
How were the readings on other important real estate indicators? NAR’s pending home sales index had advanced another half-percent in July. Housing starts rose 0.2% in the seventh month of the year, yet building permits slipped by 16.3%.3,17
As for mortgage rates, three of the four mortgage types tracked by Freddie Mac’s Primary Mortgage Market Survey became less expensive between July 30 and August 27. Average interest rates on the 1-year ARM rose from 2.52% to 2.62% in that interval, but average rates fell by 0.14% on the 30-year FRM to 3.84%, 0.11% on the 15-year FRM to 3.06% and 0.05% on the 5/1-year ARM to 2.90%.18
LOOKING BACK…LOOKING FORWARD
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends. 10-year TIPS real yield = projected return at maturity given expected inflation.
Volatility may or may not ease by the end of September. This month has opened with further indications of China’s slowing economy – poor service sector and factory PMI readings – and an underwhelming reading on ISM’s U.S. manufacturing index. If the Fed holds off on a rate hike in September, that decision may not give the market the euphoric lift some investors hope to see. If the August indicators coming out of America mostly affirm the health of our economy, then the market may find some stable ground in the diversions. Right now, China is influencing not only the minds but the emotions of investors – and when emotion creeps into investing, sometimes the wise move is to ride out the ups and downs. This year is certainly testing the patience of the equity investor.
UPCOMING ECONOMIC RELEASES: Here is the roll call for September: the Labor Department’s July employment report (9/4), June wholesale inventories (9/11), July wholesale inventories (9/10), the preliminary September University of Michigan consumer sentiment index and the August PPI (9/11), August industrial production and retail sales and July business inventories (9/15), the August CPI (9/16), a potentially market-moving Federal Reserve policy statement along with August housing starts and building permits (9/17), the Conference Board’s August index of leading indicators (9/18), August existing home sales (9/21), August new home sales and durable goods orders (9/24), the final September University of Michigan consumer sentiment index and the final federal government estimate of Q2 growth (9/25), August consumer spending and pending home sales (9/28), and finally the July S&P/Case-Shiller home price index and the Conference Board’s September consumer confidence index (9/29).
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The Hang Seng Index is a freefloat-adjusted market capitalization-weighted stock market index that is the main indicator of the overall market performance in Hong Kong. The SSE Composite Index is an index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange. The Korea Composite Stock Price Index or KOSPI is the major stock market index of South Korea, representing all common stocks traded on the Korea Exchange. The S&P/ASX 200 index is a market-capitalization weighted and float-adjusted stock market index of Australian stocks listed on the Australian Securities Exchange from Standard & Poor’s. The S&P/TSX Composite Index is an index of the stock (equity) prices of the largest companies on the Toronto Stock Exchange (TSX) as measured by market capitalization. The Bovespa Index is a gross total return index weighted by traded volume & is comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange. 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