Dow down 10% from its all-time high set in May of 2015

Is it time to panic?

A start to the year like we are having is attention grabbing. We have seen these events before and will see them again. You know Rutherford Investment Management as a long term investor and that has served our clients well over the years.

The markets and the economy were weak at the end of 2015 and getting weaker. The international monetary fund warned that the global economy was weakening; indeed they just downgraded global economic growth. The U.S. was finishing its 11th year of sub 3% growth. But on December 16, 2015, the Federal Reserve, citing an improving economy and incipient inflation, raised interest rates by 0.25 %, the first increase since June 2006.

To say they were backed into a corner would be polite. They had cornered themselves, by hawkish comments. If they had not raised rates, they would have lost credibility, but, at the end of the day, they had missed their opportunity and waited too long. By December, the U.S. and the global economies were slowing. No amount of gloss could make this sow’s ear a silk purse.

Almost immediately after the rate increase, the U.S. markets began to falter. Their end to the year was weak, and that weakness carried into the New Year.

Enter China: China is the second largest economy in the world, so it is significant when their economy slows. It has been slowing for some time. Indeed in August real weakness surfaced, and the Chinese and U.S. markets dropped sharply. The Chinese currency had just been admitted into a basket of world currencies by the IMF. This gave the Yuan new status and prestige. With their economy weakening, the Chinese saw this elevation as an opportune time to devalue their currency and gain a competitive advantage on other countries. Wrong! The currency vigilantes saw this as a sure sign of weakness in the Chinese economy, and that it was surely worse than believed. Currency traders also saw this as a sign the Chinese government would weaken the currency further and sold. Once the horse was out of the barn, the Chinese government had a hard time reversing the trend. The Chinese were forced to spend hundreds of billions of their reserves to support the Yuan. Even so, as they supported the Yuan domestically, in Hong Kong trading, just across the bridge, the Yuan was worth considerably less.

Furthermore the Chinese economy was indeed weaker than thought, or at least investors thought it was weaker, and the Chinese markets plunged, not once but twice this week it was down 7%. After August the Chinese government instituted market controls to prevent sharp drops in securities prices. They instituted circuit breakers, which closed the market if it went down by 7%. Investors now saw the Chinese market like a roach motel. You could check in but you couldn’t check out; so they sold, and sold, at every opportunity. Insiders were told not to sell. The government was forced to step in and buy securities. The Chinese government instituted controls to restrict the free flow of money, another foolish move. Since money goes where it is treated best, markets reacted negatively. People moved money out of China as fast as they could.

What this all means, is that the Chinese equity and currency markets are out of control, and the government has not dealt effectively with them. It has also meant prices of commodities, for instance oil, have tumbled. On the one hand this is good for consumers, but on the other hand bad for industrial stocks, which have plunged into a recession.

Chinese turmoil washed ashore in the U.S. just as the U.S. economy was faltering and just as the Fed was raising interest rates. A perfect storm for the markets.

Where do we go and what do we do? The markets will no doubt see more volatility and indeed may fall further, but it is no time to panic. We are selectively pruning our portfolios to account for the new reality, and when there is more clarity we will have cash to invest. The markets are just not there yet.

I am reminded of something I learned in the Army: “Hang loose, remain flexible and continue the mission”. Our mission is to make money over time, but we may not do it in short term intervals.