Market Update - Recession, Correction, Bear Market... Oh My?
All of us welcomed 2016 by celebrating with friends and family, but since January 1 the markets have given us little to celebrate. The sharp selloff since New Years has been quick and unpleasant.
Year-to-date as of January 26, the S&P 500 Index is down -6.8%, international stocks (as measured by the MSCI EAFE NR USD index) is down -8.5%, the Morningstar Long-Only Commodity Index is down -6.8% and the U.S. bond market (as measured by the Barclays US Agg Bond TR Index) is up 1.1%.
So is this is the start of a bear market or a more short-term correction? Sandi, my father Alex and I will take turns reviewing data on both sides. We've also included a link at the bottom to a Barron's article, "Bear Market Growl?" that provides an additional perspective.
First, I'll cover the good news. Low oil and commodity prices are certainly hurting the energy and mining industry, but lower commodity prices means more cash in consumers' pockets. 68% of the U.S. economy, measured by its Gross Domestic Product (GDP), is based on U.S. consumers. Recently it seems consumer savings from lower oil and natural gas prices have not been spent immediately, but to our collective credit, Americans have been paying down debt. Our financial obligations have been declining as a share of our disposable income. "Financially speaking, consumers are collectively in the best shape they've been in a decade or more," said Amy Crews Cutts, chief economist for the credit-reporting firm Equifax.
Corporate profits peaked around the summer of 2014 and were off by nearly 5% as of the third quarter of last year, according to the Commerce Department. However, corporate profits, too, have been depressed by the energy industry. An analysis from Goldman Sachs Global Investment Research found that profit margins among the companies in the S&P 500 stock index, if energy companies are excluded, have been little changed over the past year.
In the past 50 years, every recession has seen the number of jobs in the economy decline by at least 1%, and jobs have never declined by that much outside of a recession. Currently, the pace of U.S job growth has remained strong.
Finally, U.S. consumer sentiment is close to its strongest level of this business cycle. The Conference Board's index of leading economic indicators points to continued growth, and economists are still predicting around 2% U.S. GDP growth in 2016.
If you're listening to the news, you probably have the blues. The market is off to one of its worst yearly starts. China could drag the world into a recession. The Federal Reserve is raising interest rates. Oil prices are falling to new lows, and a U.S. recession might be around the corner.
These news items might be the headwinds that cause our economy to enter into a recession. These potential headwinds might have another outcome as well. The S&P 500 Index is down about 11% from its high last summer. That does cause some concern, but will this correction cause investors and employers to become more cautious, thereby leading to an economic slowdown? Or is this selloff a normal market adjustment that affords long-term investors a chance to buy at a discount?
China is certainly slowing down from an annual GDP growth rate of nearly 12% several years ago to around 6% this past year. They want their currency to depreciate and this has some people worried China is headed for a hard landing. But if their currency falls and our dollar rises, doesn't this mean lower import prices for Americans?
Oil prices have fallen around 65% from their June 2014 highs. This has caused a lot of lost revenues and jobs in the U.S. energy sector. These are difficult times for the energy industry, but this has been a huge savings for American car owners. According to CNN Money, the average driver buys about 11 gallons of gas a week, which means they'll spend $1,400 at the pump this year, down from $1,950 in 2014. These savings are then available to pay down their debt or to buy other goods and services, which in turn stimulate the economy.
Lastly, as a result of low inflation and a reasonably strong U.S. economy, the U.S. Federal Reserve raised the short-term interest rates in December 2015 for the first time since 2006. This has caused some investors to worry that rising rates, at the pace the Federal Reserve has communicated, will damage our slow-growth economy. However, after the recent market volatility, some economists think (or maybe more accurately, hope) the Fed will back off and not raise rates as much this year as planned.
If this market downturn is a correction, most corrections don't last long usually. If this market downturn portends a bear market, then we think it will be short-lived. The accompanying Barron's article mentions 5 months in its ending paragraphs. We feel that holds true as long as our economy doesn't tip into recession.
Most of us have 10-30 year time frames or longer. We don't have a crystal ball and cannot predict the next correction or the next bear market. But we can use proven strategies. A key strategy is to diversify, pairing safer low-risk investments with some higher-risk investments. We also diversify across asset classes to own investments which do well in different kinds of environments. We invest using dollar-cost averaging. We tread carefully when moving accounts from one institution to another, particularly when we have to sell everything, then move, then re-purchase investments. This isn't our first correction or our last bear market. Over time, we expect to have lower risk and still garner the long-term returns of bonds and stocks.
Bear Market Growl?: When bear markets occur without a recession, they tend to be shorter and shallower. - Barron's, January 16, 2016
Diversification and asset allocation do not ensure a profit or protect against a loss.