Equities Endure Intense Volatility,
but the Bull Market Survives
August 31, 2015
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While we think equity prices may have reached the low point for this cycle, we would not be surprised to see last week’s lows tested further.
Despite souring investor sentiment, the U.S. and global economies continue to improve.
Volatility may remain elevated, but we believe investors should still hold overweight positions in equities.
U.S. equities experienced extreme volatility last week. Prices plummeted
on Monday morning due to concerns over slowing growth in China as well
as uncertainty surrounding Federal Reserve policy. The sell-off was likely
exacerbated by trading halts, liquidity pressures and systematic investing
programs. Markets recovered later in the week as investors viewed conditions
as oversold, and as oil and other commodity prices stabilized and advanced.
For the week, the S&P 500 Index gained 1.0%.1 The energy, technology and
consumer discretionary sectors led the way while utilities sold off sharply.1
Weekly Top Themes
- The revised second quarter gross domestic product report was solid and
showed broad-based improvements. Real GDP was revised from 2.3% to 3.7%,
while nominal growth improved from 4.4% to 5.7%.2 Nearly all segments of
the economy showed improvements, with capital expenditures demonstrating
particular strength.2 Additionally, the report confirmed the ongoing trend of
domestically-oriented companies experiencing better results than multinationals.2
- Consumer confidence rebounded in August. The Conference Board Consumer
Confidence Index rose to 101.5 this month, marking its second-highest level
of the current expansion.3 The increase is a particularly welcome sign for future
economic growth since it follows a downturn to 91 in July.3
- The slowdown in China should boost U.S. economic growth. In particular, we
point to a decline in energy prices. U.S. gasoline prices are down 25 cents per
gallon so far this month.4 Lower energy prices should boost consumer spending.
Similarly, general economic unease has kept mortgage rates low (30-year fixed
mortgage rates are now below 4%).4 This should prompt increased spending on
housing, which should also help the broader economy.
- Uncertainty over a potential Fed rate hike in September has increased.
New York Fed President William Dudley stated at a news conference that recent
market turmoil makes the case for a hike next month "less compelling." He also
indicated that views could change as new data emerges, but a September rate
hike could require continued strength in economic data and more stable markets.
- Last week’s market lows may be tested further. The history of market
corrections suggests that "V bottoms" are rare following the type of technical
damage done early last week. We would not be surprised to see an additional
pullback in the coming days or weeks, but we also think there is a better than
even chance that we have already seen the lows for this cycle.
Volatility May Continue, but Sentiment Should Improve
The markets have been in turmoil since the Chinese currency devaluation a few
weeks ago, which fueled concerns over the strength of the global economic recovery.
A further slide in oil prices compounded these fears. Ironically, these concerns
escalated at the same time U.S. growth has been accelerating and Europe survived
the latest Greek debt issues. Investors remain uneasy and prone to pessimism. We
expect market volatility to remain elevated, even as data suggest the U.S. and global
economies are continuing to expand.
Concerns over slowing growth in China are unlikely to go away. Many investors
have long awaited signs that China was on the verge of implosion. We are not
discounting the real effect that weaker growth in China represents, but we also
believe that most observers are overly focused on the downside. The pullback in
energy prices, for example, should provide more positives than negatives for the
Investor sentiment has clearly taken a hit and will take time to recover, but we
expect investors will slowly move back into equities. Our view is that we have
probably seen the worst of the current corrective action, and we do not believe we
are at the onset of a new bear market. Volatility is likely to remain high, and there
could be further downturns in the near-term, but we continue to believe it makes
sense for investors to hold overweight positions in equities. Our overall view of the
current equity market remains unchanged: The bull market is not over, but the easy
money has already been made. Gains will be tougher to come by and volatility will
be higher, which means that selectivity has become increasingly important.
1 Source: Morningstar Direct, as of 8/28/15
2 Source: Bureau of Economic Analysis
3 Source: Conference Board
4 Source: Cornerstone Macro
Last Week's Commentary
The Correction May Not Be Over, but the Bull Market Should Persist
August 24, 2015
To put the downturn in perspective, the S&P 500 Index has more than tripled since 2009 and is only 7% off its all-time high.1
The S&P 500 has a dividend yield of 2.2%, out-yielding the 10-year Treasury.2 History shows that when equity yields are higher than bond yields, it’s usually a buying opportunity for stocks.
The sharp sell-off has done some technical damage to the markets, which could take some time to repair.
Equities may be currently oversold, but we may not yet have seen the lows of this cycle.
The most important signs to mark a turnaround are likely to be clarity on better corporate earnings results and stabilizing commodity prices.
What Happened? Why?
The S&P 500 Index fell 5.7% last week, its biggest weekly pullback since September
2011.1 Equities have been under pressure for some time, and it appears that
investors finally gave in. Several factors drove the sharp sell-off: 1) A months-long
decline in earnings expectations 2) Widening credit spreads 3) Further evidence of
economic weakness in China and the devaluation of the yuan 4) Generally slowing
global growth, along with commodity price weakness and deflationary concerns
5) Uncertainty over Federal Reserve policy 6) Technical deterioration over the last
few months 7) Investor nervousness and typically thin summer trading volume.
Has the Economic and Market Backdrop Deteriorated?
In our view, sentiment may have taken a hit and will take some time to recover. That
may have some near-term negative implications, but we continue to believe that the
global economy (and the U.S. in particular) remains sound. Investors have become
increasingly concerned about growth prospects, deflation and liquidity trends, with
the sharp downturn in oil and commodities being at the epicenter of these worries.
The abnormally slow and choppy recovery has also acted as a drag on sentiment over
the past few years. Moreover, many are worried that the Fed will make a mistake by
We have seen multiple periods of intense but short-lived “risk-off” phases since the
end of the Great Recession, and we believe we are in the midst of another one. We
remain relatively upbeat about the global economic growth outlook. Many regions
continue to struggle, but we believe forward indicators point to an acceleration in U.S.
growth, driven by higher levels of consumer spending. Furthermore, we firmly believe
that lower energy prices are a net positive for the U.S. economy and should act as a
tailwind for corporate earnings in the coming quarters. Increasing anxiety and the
current downturn may delay Fed rate increases. But when the Fed does act, we think
a modest rate increase should prove to be a near non-event since policy will remain
relatively accommodative. Pessimism remains high, which will likely keep markets
unsettled. However, we believe investors will look back on the present time as being
little more than a bump in the road during a period of slow and uneven growth.
What Should We Expect from Here?
Market pullbacks of 5% or more are not uncommon during bull markets. We think
volatility will remain high, and we may not yet have seen the bottom of this selloff.
We expect markets will recover and do not think we are nearing the end of the
current bull market.
What will it take for equities to resume their uptrend? For one, we need more
consistent and clearer signs that economic growth is on track and that corporate
earnings have recovered. We expect the global economy to regain momentum, led
by the United States and Europe. We also forecast better earnings growth in the
coming quarters. Additionally, we think equities will remain under pressure as long
as credit spreads are widening. Many of the same factors that caused the equity
market downturn have put pressure on fixed income credit sectors. If oil prices were
to stabilize and liquidity concerns to fade, this would go a long way toward helping to
ease pressure on both asset classes. Finally, we think investors will require signs that
the Chinese economy is not entering a free fall. China’s economy is clearly in trouble,
but we think policymakers will engage in additional easing measures to promote
growth. This should assuage fears that the country is facing a hard economic landing.
None of these factors is likely to emerge quickly or easily, but we do think they
should eventually come to pass.
How Should Investors Position Themselves?
Pessimism is on the upswing and equity sentiment has soured in favor of cash and
Treasuries. That may not change quickly, but we are leaning against the tide and
believe the case to overweight equities remains sound.
So what should investors do? This may present an opportunity for investors sitting
on cash waiting for a market pullback. In contrast, locking in profits may benefit
those who have enjoyed the tripling of stock prices since the 2009 low. And for all
investors, although we do not believe this bull market is over, we think the pace of
gains is likely to slow and volatility should pick up.
1 Source: Morningstar Direct, Bloomberg and Standard & Poor’s as of 8/21/15. The S&P 500 Index dropped to 666 in March 2009 and peaked at 2,131 in May 2015.
2 Source: Bloomberg as of 8/21/15. The 10-Year Treasury yielded 2.04%.