Of Sheiks and Shale

”None of the postwar expansions died of old age; they were all murdered by the Fed.”
-Rudi Dornbusch, MIT economist

In May 2015, the markets hit an all-time high. By August the markets were down 11%. The decline was due to an apparent slowing in the Chinese economy and a surprise devaluation of the yuan by China. While the Chinese economy, the second largest in the world, appeared to be slowing, confirmation was hard to obtain owing to the opaque nature of Chinese economic reporting. But, there was no mistaking the yuan devaluation; it caught everyone by surprise. Another sign that the Chinese economy was slowing was the decline in commodity purchases by China. Lacking many resources, China is a big buyer of commodities on the world stage, and producers were definitely seeing a slowing of purchases. With the yuan falling and commodities weakening, Chinese investors began to pull money from their markets and move money out of China. Companies did the same. The Chinese equity markets tumbled. This upheaval was felt throughout the world, as prices of commodities fell sharply. Extraction of natural resources, except for oil, was cut back. The price of oil fell dramatically.

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More Uncertainty
In March of this year the markets were hitting new highs. All indices shared in the festivities. The unemployment rate dropped to nearly 5%. Oil prices dropped too, giving hope to the consumer economy and diminishing inflation expectations, as inflation all but disappeared. In general, the outlook for the economy was positive. Then, slowly, the outlook began to change.

The International Monetary Fund spoke frequently of the declining outlook for the global economy. We had noted that previously, and we moved our money back to the U.S., saying the U.S. was the “best house on a bad block”. Commodity prices, other than oil, began to decline in response to China’s slowing growth rate.

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June Swoon

S&P Quarterly results were plus 0.3% through June 30, 2015. Year to date results were positive 1.2% through June 30, 2015. Year to date the market has been volatile, barely holding on to gains for the year. Volatility will continue. Upward moves during the first half were later given up over geopolitical concerns.

At home, GDP growth has been slow, profits so-so and the markets have just not had the catalyst for gains. Headlines have complicated matters. The long dance regarding interest rates has teased investors. Overseas, Greece and China have loomed large. Each time Greece has appeared about to default or leave the Eurozone, or both, the markets have reacted negatively. Each time it appeared a deal between Greece and its creditors might be imminent, the market reacted positively.

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Global economy slows
In this past quarter volatility increased in markets throughout the globe. The Chinese economy, second largest in the world, saw its growth slow even as its equity market doubled. Germany, France, Italy and the U.K. also slowed. Even the U.S. economy, long the strongest in the world has slowed, having been battered by ferocious winter storms and a West Coast port strike. The response in the ex U.S. countries has been to cheapen their currency in an effort to grow exports and grow their economies. Interest rates have been slashed. Europe has embarked on its own version of Quantitative Easing to promote its economies. This strategy has yet to work. Meanwhile, the U.S. Federal Reserve has played with raising interest rates in the U.S., but so far has not had the courage to do so. Talk of raising rates has had the effect of increasing anticipation that interest rates will rise, and the U.S. Dollar has strengthened. Although equities in many countries have increased, the increase relative to U.S. investments has been diminished by the stronger dollar. The dollar has increased 18% against a basket of currencies in the past year and up 30% year on year to the Euro.

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Markets Hit Highs In 2014

Calendar year 2014 turned out to be a positive year for the markets with all indices making a strong showing. The year had its dips, with strong drops in January of 3.5% and in both July and September of 1.4% each. As December went on, the market staged a strong rally, until it ran out of steam. In the last days of December 2014, the market began to falter. By then, the markets had been in strong upturn for the year, and since March 9, 2009 up 244%. The market began to look tired, as well it might after 70 months of this bull market.

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Client Newsletter – Quarter Ending September 30, 2014
Last month in our Daily Journal of Commerce column, we warned that September and October could be volatile months, months with a downturn. There were many reasons for this forecast. History was one, with both September and October demonstrating a tendency to be volatile and lower. Further, the market has had an over five year run up and was due for a correction. Also, there were and are many headline events to worry about: problems in Europe, specifically Ukraine; a slowing Chinese economy, with attendant pullback in commodity prices. Then there is Ebola which has taken center stage, and ISIS. These problems persisted and in some cases grew worse. September turned out to be a volatile and down
month.

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Client Newsletter – Quarter Ending June 30, 2014
The second quarter of 2014 saw a return to market increases after a rough first quarter of the year. In fact, the government revised the first quarter GDP to a minus 2.9% from the positive 1% previously reported. The start of Obamacare and severe winter weather were the reasons most cited for the negative growth. Additionally, the Russian acquisition of Crimea and revolutions in the Middle East were events unsettling to the markets.

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In 2013, the market had one of its best years ever. The broad market, as represented by the S&P 500 index, was up 29.6%. Typically, after a strong year, the market will continue on its course. After a nearly unbroken upward climb since March 6, 2009, one of the longest bull markets in history, the market was due for a pause, maybe even a correction (defined as a 10% drop). This year the market continued to reach all-time highs and then took a breather. The market appears tired, but its current pause so far appears in character and no cause to panic.

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The market had a remarkable year last year, gaining 32.39% in the S&P 500 index. To put it in perspective, the S&P 500 has gained over 20% in a calendar year 21 times since 1945 that is 21 times out of 68 years, or almost 31 % of the time. This amazing statistic is reason enough for remaining fully invested in the market. Even when times are grim, and the market is off, one should remain invested. In the same 68 year period, the market has gained over 30% just six times. Still this almost 10% records of gains is also a strong argument for staying invested.

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Client Newsletter -– Quarter Ending September 30, 2013
The third quarter of  2013 saw a continuation of the robust market that this year has brought. In spite of worries, mostly over government problems, unemployment, and fears over Federal Reserve policy, the markets have risen to record or near record territory. Both the S&P and the Russell 200 are at all-time highs. The NASDAQ is at a 13 year high (but still 29% off its all-time highs). That the markets have been able to climb this wall of worry is a good sign, not only because returns are good, but it is a good situation because worries have kept the markets from being overly exuberant. I have detailed the stresses in the markets in previous columns and letters, so it is not necessary to review them again, but it is encouraging that the markets have surmounted these worries.

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