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Alan McKnight, MBA, CFP®
October 19, 2015
The 3rd quarter of 2015 was a tough one for investors. For nearly four years, stocks had been heading in one direction, up! However in August, the S&P 500 officially entered correction territory, defined as a decline of 10% or more from the most previous high.
Many of the most respected companies declined due to increased fear driven by economic stress in China (the world’s second largest economy behind the US) as well as issues with Greece.
After several healthy years, the equity markets took a break from their continuous upward movements. For the 3rd quarter, the S&P 500 fell 6.9% and was down 6.7% year-to-date; this was the index’s worst quarter since 2011. The Dow was down 7.6% for the quarter and down 8.6% year-to-date while the NASDAQ was down 7.3% for the quarter but only down 2.4% year-to-date.
Ironically as of this writing, October 18, 2015, the year-to-date returns for the Dow, S&P 500 and NASDAQ are -1.5%, +0.3% and +3.1% respectively, so the recovery has been very quick, only taking about two weeks!
Although most long term investors understand that over long periods of time the equity markets can provide reasonable returns, the market swings of the 3rd quarter seemed to be tougher psychologically this time around, and even some of the most disciplined investors were afraid to buy on the dips. During these times, it is very natural to have many questions when the markets are moving violently on a daily basis. Volatility is common, and more times than none, the wisest thing to do is stick with your long-term investment plan. We need to always remember that volatility and periodic corrections are common in equity markets. The key to getting through unexpected turbulence is to understand that swings in the financial market are normal, and relatively insignificant over the long haul.
Market pull backs are not new, but during the fall months, investors are bracing for additional large price swings across stocks and bonds heading into a month that is usually associated with tumultuous markets. Although it has been a tough year for the markets, many analysts remind us that other signals of a U.S. recession haven’t materialized. They still expect the U.S. economy to expand at a modest 2.0% to 2.5% annualized rate this year.
Some market strategists seem to be less upbeat than in past years; however, guarded optimism still remains. The main dissention in the group is over how fast and how far markets will move. “U.S. stock valuations are reasonable given the prospects for growth and inflation,” says Russ Koesterich, Global Chief Investment Strategist at Blackrock, who worried about “stretched” valuations in December. Near term he feels stocks are still “particularly attractive relative to bonds.” Dubravko Lakos-Bujas, Chief U.S. Equity Strategist at JPMorgan Chase agrees. He feels that compared with International markets, the U.S. provides stocks of superior quality.
Analysts are cautious for now, but among 21 strategists followed by Birinyi Associates, the average S&P 500 price target for 2015 is currently 2177. If it ends the year at that level, it would mark a gain of 5.8%, lower than the 8.4% increase forecast in the middle of this year, but still up.
Will the Fed raise rates or won’t they? That still remains the main question when it comes to interest rates. The U.S. economy is progressing, but not at a pace sufficient to warrant raising interest rates, according to the Federal Open Market Committee (FOMC). After its September meeting, the FOMC indicated that, while there were improvements in some economic sectors such as labor and the housing market, other areas have lagged, including business and exports. With inflation still running below the Fed's target rate of 2.0% and the economic uncertainties in China, the FOMC stressed continued patience, yet indicated its expectation that interest rates will be raised sometime this year. Stay tuned!
History has shown that the first interest-rate hike in a Fed tightening cycle is not the start of a market or economic downturn. In the past, economically sensitive assets, such as equities, have performed well during the period immediately after the initial hike. A Fed rate hike might also remove the doubt that some investors may have about monetary policy and the U.S. economy, which may have the offsetting effect of boosting investor confidence. Even if later this year in October or December, the Fed issues its first interest rate hike in over nine years, analysts feel it won't give the economy a sharp kick. They are suggesting it will be more of a gentle nudge, though significant. Once again investors will need to keep a watchful eye on interest rate movements.
Global Concerns & China
China's slowing economy sent global markets reeling this past summer. Already at its slowest pace in 25 years, China is struggling to reach its target growth rate of 7% for the year. Adding to concerns about the weakening of the world's second largest economy is the Chinese government's repeated intervention in an attempt to halt a massive sell-off and stabilize its securities market. Interest rates were cut and bank reserve ratios were lowered, allowing for more money to be available to borrow for investment. However, Chinese banks are facing increasing economic risks due to the increasing number of bad loans, further dampening the Chinese economy.
On Monday. October 19th, China did report that its GDP growth for the 3rd quarter slowed to 6.9%; we haven’t seen a number that low since 2009. Russ Mould, investment director at AJ Bell said that “Chinese headline GDP growth looks healthy at 6.9% but underlying metrics suggest the real growth rate could be nearer 3%-4%. If you look at growth in rail cargo traffic, electricity consumption and demand for loans, three metrics favored by Prime Minister Li, the picture is not so healthy. Credit growth still looks promising but freight shipments and electricity demand growth look to be sagging, so the so-called Li Keqiang index does raise a few questions. Today’s GDP figures are encouraging but investors with exposure to China should still expect some bumps and lumps along the way.” I would agree.
This summer, Greece's debt crisis culminated in an agreement with its creditors on an 86 billion euro bailout, which may have allowed the country to remain in the Eurozone. Greek Prime Minister Alexis Tsipras, despite campaign promises to write off debt and ease austerity, ultimately negotiated the terms of the new deal, which included stricter austerity measures than had previously existed. Tsipras subsequently resigned, calling for new elections in September, which resulted in his reelection as prime minister and leader of his left-wing Syriza party. Whether the Greek economy can muster enough support to comply with the requirements of the new debt deal remains to be seen.
"Global equities are closing in on their worst quarter since 2011, with a number of factors fueling fears in an already jittery market, including weak global growth, driven by deceleration in emerging markets, particularly China," Barclay’s analysts said in a late September report. China's benchmark Shanghai Composite appeared to be one of the world's worst performers of the quarter with a 25% loss, its weakest performance since 2008. In Europe, Germany’s Dax experienced a 15% decline, -11% for the French CAC, -8% for Italy and -13% for Spain’s IBEX. Moving forward, many analysts are expecting a cloud of pessimism to loom over global equity markets for a while.
Oil prices have fallen a long way over the last year. For the quarter, both Brent and U.S. crude oil were down 24% for their sharpest decline since the end of 2014. Heading into the 4th quarter, analysts are predicting that energy markets should stabilize as production in the U.S. subsides. The falling of oil prices has both positive and negative impacts on the economy. On the negative side, prices of oil stocks and employment in oil and oil-related industries has declined. This hit to the energy sector has taken a toll on the earnings of oil related stocks and has delayed or canceled many of their planned capital expenditures. On the positive side, consumer relief at the pumps should turn into more savings or ability to spend for consumers.
Analysts also feel that it now appears the majority of the damage has been done and oil prices may be stabilizing. Oil prices contributed to the market’s decline and are another concern that need to be monitored by investors.
What Can an Investor Do?
The more an investor fixates on daily market fluctuations, the more volatile and risky it will appear. Cyclical declines of 5% to 20% or more are common. The U.S. stock market has, in the past few years, been extraordinarily placid by historical standards. Even the sudden drops of the past month are well within the long-term norm. Fixating on fluctuations in the short term will make it harder for an investor to remain focused long-term investing goals.
Have a plan! Every investor needs a disciplined plan. When equity markets are gyrating on a daily basis it is easy to make emotional decisions that could prove to be wrong.
Focus on your own personal objectives! During confusing times it is always wise to create realistic time horizons and return expectations for your own personal situation and to adjust your investments accordingly. Understanding your personal commitments and categorizing your investments into near-term, short-term and longer-term can be helpful.
Don’t try to time or predict the market! Investment decisions driven by emotion can cause problems for investors. Discipline and perspective can help investors remain committed to their long-term investment programs through periods of market uncertainty. The best investors try not to constantly look back and second guess their decisions. They make decisions based on facts.
A portfolio strategy can assist in helping youweather ups and downs of the market. Corrections are a normal part of investing. With a strong plan in place, many investors need not worry or adjust their approach at all. If you are going to make changes, you should try not to panic and sell equities.
Make sure you have adequate liquidity! When the market is down, cash can be a valuable shock absorber. You may want to consider using the cash portion of your portfolio to delay the need to sell equities while the market is down. Selling equities in a downturn leaves you with less invested when a recovery comes, turning what may be a temporary market decline into a permanent dent in your portfolio. Having cash on hand may help give you the opportunity to participate in a recovery.
Get used to volatility! It’s not going away. Volatility and market declines are a part of investment history. Warren Buffett maintains that, just because markets were volatile doesn't mean that for a long-term investor, which is the prism through which Buffett sees markets, the stock market was necessarily riskier. He advises investors not to confuse volatility with risk.
Of course, as always, discuss any concerns with us. Our advice is not one-size-fits-all. We will always consider your feelings about risk and the markets and review your unique financial situation when making recommendations.
We offer consistent communication, a schedule of regular client meetings, and continuing education for every member of our team on the issues that affect our clients.
A good financial advisor can help make your financial journey easier. Our goal is to understand our clients’ needs and then try to create a plan to address those needs. We continually monitor client portfolios. While we cannot control financial markets, interest rates or geo-political events, we will always keep a watchful eye on them. No one can predict the future with complete accuracy, so we keep the lines of communication open with our clients. Our primary objective is to take the emotion out of investing. We can discuss your specific situation at your next meeting, or you can call to schedule an appointment. As always, we appreciate the opportunity to assist you in addressing your financial matters.
If it’s been more than a year since your last financial review, please give Jan Berkholtz a call at our office to schedule an appointment so we can make sure everything is in order. If you feel the need to discuss your situation before our next scheduled review, please call our office at (770) 951-9001 or e-mail me at firstname.lastname@example.org.
Alan McKnight, MBA, CFP® is Vice President of Kays Financial Advisory Corporation. He has over 19 years of experience working with retirees and pre-retirees. He is also an Adjunct Faculty Member and Professor of Finance and is an Ed Slott Master Elite IRA Advisor. He can be reached at (770) 951-9001 or at email@example.com.
This report and Mr. McKnight’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any company and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned herein.
Sources: Wall Street Journal, Barron’s, Vanguard, Seeking Alpha, Fidelity, Morningstar, Forefield, MarketWatch.