A Note from the CIO
August 23, 2015 – As you probably know, it is not my usual practice to comment on short-term market swings. Part of the deal investors accept when they own high-returning assets such as stocks is that, from time to time, asset prices will go up and down in dramatic fashion. Ignoring such short-term noise is generally the best course of action. Nonetheless, I thought I would offer some perspective as the market’s declines on Thursday and Friday (August 20th and 21st) were certainly the sharpest downward moves in US equities since 2011.
In our recent quarterly investment letter, we stated that the market perceived Greece as the greatest risk, followed by China and, finally, the upcoming US interest rate hike. We also pointed out that Pitcairn’s pecking order was exactly the opposite – first US interest rates, then China and, finally Greece. Last week showed our view to be, at least mostly, correct. On August 19th, the Federal Reserve released the minutes from its July 28-29th Federal Open Market Committee meeting, which showed the Fed’s concern about China’s economic growth and market turmoil, as well as broader weakening in emerging market economies. The minutes also indicated the Fed’s view that a weakening global economy has revealed some areas of vulnerability in an otherwise fundamentally sound US economy.
Clearly, the market took the Fed’s worries about emerging markets as a reason to sell. Investors quickly came to believe that the Fed would almost certainly postpone any interest rate action it was contemplating, shifting from September to at least December (a timetable we have been forecasting for some time now). Perhaps more troubling to the markets is the possibility that, even in December, economic momentum could be weak, potentially putting the Fed’s interest rate increase on indefinite hold. We have long stated that the Fed would much prefer to deal with a bit of real inflation than a deflationary scare and the market took last week’s news as a sign that the Fed’s deflation concerns have increased. We have also pointed out that the market would likely soldier through an orderly reversal of the Fed’s monetary policy, with the bull market intact. The real threat is if the Fed missteps or the market loses confidence.
So where are we? To be sure, China’s economic picture is not an attractive one at present. First quarter GDP growth came in at 7%, beating the 6.5% expectations, but ranking as China’s lowest GDP growth since the first quarter of 2009. Furthermore, its stock market reversed a speculative run up with a spectacular plunge earlier this summer. The reforms the Chinese government is trying to institute will take time, so volatility in China’s economy is certainly not the game changer that social unrest or a political coup might be. We see no signs of such cataclysmic events on China’s horizon.
However, China’s economic woes are a secondary concern. The overriding force that drove the market last week was the apparent reality that investors will not respond to the first US interest rate increase in 11 years in a calm and measured manner. This leads me to believe that though we might see continued selling early this week or an upward bounce in equities due to the oversold nature of the market in the short run, we should not expect this to be a one or two-week event. It may well take a bit longer for markets to regain confidence in the Fed’s capability to successfully engineer a tricky transition.
Still, as we move into fall, I believe a clearer picture of US economic growth will resolve the market’s recent doubts about the Fed’s ability to raise interest rates. Right now, US economic data is flashing yellow, not red. Some recent manufacturing data was weak, but housing data remains strong. We are more than confident that the dollar will stay relatively high and oil prices will remain low. The former hurts the earnings of US-based multinational companies, but the latter supports domestic and global consumption.
In summary, last week’s market results represent one of three scenarios:
- A dramatic, but short-term sell-off reminiscent of August volatility in recent years
- The start of a two to three-month correction (the first since August 2011), characterized by ongoing fears about a Fed misstep
- A long-term inflection point marking the end of the secular bull market
In aggregate, the data points we combed over this past weekend lead us to either the first or second alternative. That said, you can rest assured that as this situation evolves, Pitcairn will continually assess the data and appropriately position our clients for long-term success.
We caution you to expect a volley of calls for the apocalypse from pundits and media “experts.” Please remember that many of the gurus who are now predicting poor performance for US stocks over the coming years (including Marc Faber and Mohamed El-Erian) have been forecasting low returns in US equities for seven years. They (and their followers) completely missed an historic bull market!
As a Pitcairn client, you are undoubtedly well aware of how strongly we believe that a long-term plan with a mix of asset classes, guided by the best investment managers and mindful of fees and taxes offers the best opportunity for success. We also understand that a sound plan can only deliver the desired results if we have the fortitude to stick to that plan even in uncertain or challenging conditions. With several significant clouds in the current forecast, our fortitude may soon be tested. Pitcairn clients can rest assured that their portfolios are positioned to weather all manner of economic and market conditions. If you have any questions or concerns about how your personal assets are positioned for whatever the capital markets have in store, please contact us. And as always, we thank you for your continued confidence and support.