The following post is from an email sent to Gould Asset Management clients on August 24, 2015. It is shared here for the benefit of our blog readers, in hopes it provides some helpful context for understanding the market’s recent volatility.
As you are likely aware, markets around the world have dropped sharply over the last four trading sessions. The S&P 500 benchmark of leading US stocks is down almost 11% from its August 18 closing level. In market parlance, this qualifies as a “correction.”
China’s surprise devaluation of its currency, the yuan, on August 11 seems to have been the catalyst for the decline. Many have inferred that the Chinese economy must be in worse shape than was previously thought. Given China’s outsized influence on other economies around the world, this is legitimate cause for concern.
The US market experienced panic selling at its opening this morning, dropping more than 5% from Friday’s close. The remainder of the session was highly volatile, with the market closing down about 4% on the day, but about 1% above its opening low point.
As investors absorb headlines from today’s market drop, we would not be surprised to see more panic selling at Tuesday’s market opening. But at some point, and we think soon, the panic selling will exhaust itself and investors will reconsider the market in a more sober, less emotional way.
No one can know at this time the extent to which China is slowing or the impact it will have on the world’s economies and financial markets. Time will tell. (more…)
Note: This post is an excerpt from Gould Asset Management’s Economic and Market Review for the Second Quarter of 2015. The excerpt is posted here for the benefit of our blog subscribers.
Equity market performance was mixed in the second quarter, as signs of improving economic growth were offset by concerns over the continuing Greek debt crisis and fears of rising interest rates. US stocks, as measured by the S&P 500 index, were largely flat on the quarter, although their scant 0.3% gain allowed the index to claim its tenth consecutive quarter of positive return, the longest such run for US stocks since 1998. With two consecutive quarters of small gains in 2015, the year-to-date return for the S&P 500 stands at a modest 1.2%.
The technology-heavy Nasdaq Composite index was one of the few bright spots for US markets (up 2.0%), briefly surpassing its previous all-time high set in March 2000 at the peak of the dot-com bubble. Other top performing US sectors included health care (up 2.8%), consumer discretionary (up 1.9%), financial services (up 1.7%), and telecommunications (up 1.6%). The strong gains in health care were largely driven by a variety of mergers and acquisitions activity, as well as the Supreme Court’s ruling upholding subsidies under the Affordable Care Act. The worst performing sector was the interest-rate-sensitive utilities sector (down 5.8%), as investors grew skittish about the potential for future interest rate hikes. (more…)
Recent announcements about Puerto Rico’s runaway debt crisis have thrust the island territory’s long-running economic woes into the national spotlight. In late June, Governor Alejandro Padilla García warned that the U.S. commonwealth was alarmingly close to default on its $72 billion debt – far more per capita than any US state. Puerto Rico’s struggles result from a kind of ‘perfect storm’ of financial blows. A dismal job market (unemployment currently stands at 12%) spurred population decline as Puerto Ricans moved to the mainland for work. Faced with a shrinking tax base, inefficient administrations then spent years relying on lenders to pay for pensions, social services and other budgetary gaps. Now, investors from hedge funds to individual bondholders could be hit with potential losses.
The larger question for the US economy is whether Puerto Rico’s current drama could make investors more skittish about taking on municipal debt. In theory, such a shift could change the equation for state and local governments nationwide that rely on bond measures to fund everything from schools to sports arenas. Comparisons to Detroit are logical, but Puerto Rico’s unique commonwealth status excludes it from the Chapter 9 bankruptcy protection afforded to all 50 states. This leaves the territory with less room to maneuver, though it is reaching out to creditors and Washington to help coordinate a broad restructuring of its debts. No matter how the situation develops, we continue to watch Puerto Rico closely, keeping attuned to any potential fallout in US markets.
Following last Friday’s employment report, which indicated increasing upward pressure on wages, anticipation of an initial rate hike from the Federal Reserve grew stronger. The consensus expectation is for an increase in the federal funds rate (the short-term interest rate controlled by the Fed) later this year, probably in September. Longer-term rates have already risen significantly – the yield on the 10-year US Treasury note is now at 2.39%, up from 1.68% in February.
To understand how rising interest rates impact portfolio returns, it is important to understand how a change in rates affects the prices of existing bonds. Bond prices and interest rates move in opposite directions, so rising interest rates means lower bond prices. This happens because the interest rate on newly issued bonds is higher than before, making the fixed interest rate on existing bonds relatively less attractive by comparison. The longer the term of a bond, the more sensitive its price is to changes in interest rates.
Note: This post is an excerpt from Gould Asset Management’s Economic and Market Review for the First Quarter of 2015, the entirety of which can be found here. We’ve reprinted it here for the benefit of our blog subscribers.
US stocks got off to a cooler start in 2015, with the S&P 500 index rising a modest 1.0% in the first quarter. For some investors, this might have seemed a bit of a letdown, given the fourth quarter’s 4.9% return and 2014’s full-year return of 13.7%. Glass half-full investors, on the other hand, would point out that this was the ninth consecutive positive quarter for US stocks—a remarkable run and the longest such streak since 1998. Like all streaks, this one will eventually end, but how and when is anyone’s guess.
Illustrating just how difficult it can be to predict US market movements, we seem to be in that odd environment where bad economic news is good market news, and vice versa. This contradictory state reflects the impact of Federal Reserve monetary policy on stock prices—investors hope that weak economic data delays the Fed’s eventual rate hikes, while strong economic signals hasten it. How much longer the proverbial punch bowl of easy money and low interest rates persists will be a key factor in near-term performance, since the varying expectations are clearly having a large effect on the US stock market.
To continue reading, please see our entire Economic and Market Review here (link will open in a new window).
To understand how rising interest rates impact portfolio returns, it is important to understand how a change in rates affects the prices of existing bonds. Bond prices and interest rates move in opposite directions, so rising interest rates means lower bond prices. This happens because the interest rate on newly issued bonds is higher than before, making the fixed interest rate on existing bonds relatively less attractive by comparison. The longer the term of a bond, the more sensitive its price is to changes in interest rates.