Global equity markets have been selling off. The chart shows the equity price decline, in dollars, of stock markets in U.S., Europe, China and Brazil over the last twelve months. The American market, the S&P 500 index in the chart, has been the most resilient with a -9.9% decline vs. much larger declines in other markets.
What are the concerns?
- Although the Chinese economy is still growing, it is doing so at a slower rate as it attempts to transition from a manufacturing to a consumer and service driven economy. The emphasis on manufacturing and export has lead to an over-investment in factory capacity. The suppliers of raw materials to China, such as Brazil, have been hit hard by this slower growth and transition.
- The European economy is growing and is recovering from its painful adjustments to the debt crisis in Greece, Spain, Italy, Ireland and Portugal. The Euro zone purchasing managers index (PMI) at 52.3 remains above 50 indicating continued growth. They are now grappling with the influx of refugees from Syria and North Africa.
- What about the good old USA? Our PMI is at 48.1, down 3 months in a row from 50.1 in October suggesting a slowing economy. We have had PMI readings below 50 briefly in the last 5 years and the economy continued to grow. The PMI gives an indication of current conditions but is not necessarily predicting the future. We currently have a robust economy with a low, 4.9 % unemployment rate and a low inflation rate of +0.7 %. Although the Federal Reserve Board has begun to raise short term interest rates, the increase has been minimal and they are likely to put off further increases in the face of slow global growth. The U.S. dollar may continue to strengthen as the European Central Bank “prints money” to stimulate their economies with a policy of buying bonds called “quantitative easing”. A higher dollar makes U.S. exports more expensive.
- Oil prices have collapsed and further supply is likely to enter the market with the Iran nuclear deal allowing Iran to export oil above board. Low oil prices are the result of both over-supply and a lack of demand. The low oil price impacts the oil companies in the U.S. and their suppliers and local economies, as well as, oil producing countries worldwide. They will lay off workers and stop buying capital equipment. This is a drag on the economy of the U.S. and other oil producers. The flip-side is that low oil and gasoline prices act as a huge tax cut for consumers and businesses and should stimulate economies. One example of a direct beneficiary of cheap oil is the airline industry. Airlines are booming as low fuel costs have improved their margins and profitability. Plus, consumers have more money to spend and can travel more.
The media are filled with stories about the potential for recession due to the Global slowdown. We make no predictions. The World economy is complex and the future is unknowable… until we get there. However, when markets sag and manufacturing slows, it can be prudent to raise cash levels and become defensive. We raised cash in December and early January.
Lower market prices lead to excellent buying opportunities. A defensive cash position allows investors to profit from lower stock prices when conditions stabilize. Historically, the best investments have been profitable company stocks selling at a reduced price relative to the overall stock market. We believe this will continue to be the best portfolio for long term portfolio growth. This is especially true after a market sell-off and stocks are “on sale” at bargain prices.