It is said that timing is everything.
For those expecting my usual newsletter talking about the month that was (complete with some sports, music or Terminator reference) July's edition will be different. One of the benefits of sending the newsletter out a few (ok, several) days after the month's end, is that I have the flexibility to adjust what I write about should something important happen in those first few days of the new month.
A sharp two-day global stock sell off (such as we had this past Friday and Monday) is definitely important enough for me to utilize this flexibility and address what is happening in (semi) real-time. Even better, I promise to keep my trademark analogies to a minimum.
If you haven't been following the market in early August, here is a snapshot of what's happened:
As you can see from the chart above, all major stock indices took a beating between August 1st and 5th. Small U.S. stocks (RTY) fell the hardest losing near 7% of value. The tech heavy Nasdaq (CCMP) was down nearly 6%, with the large U.S. stock centric S&P 500 (SPX) losing nearly 5% for the two day stretch. International (EFA) and Emerging Markets (VWO) were not spared falling nearly 4% each.
Short term Treasury bonds (BIL) were flat and the overall bond market (AGG) was actually +1%.
Before I get into a few of the myriad reasons why the market went down so swiftly, let's zoom out and look at July's returns first:
Small U.S. stocks had a tremendous July adding 11% for the month. Bonds (AGG) were up nearly 3% and international stocks (EFA) returned nearly 3% and 2.5% respectively. Emerging Markets (VWO) and large U.S. stocks (SPX) generated approximately 1% in growth. Short term Treasuries were basically flat, leaving the Nasdaq as July's biggest loser netting a -1.57% decline
So what happened to cause this swift decline and does it signify some major shift in our economy?
Is inflation back? Doesn't look like it.
Are corporate earnings declining? Nope, earnings have still been solid.
Is our country's economy (GDP) shrinking? Very doubtful, with 2nd quarter GDP tracking at +2.8% well above its forecast of +2.1%.
Was it something to do with unemployment then? Ok, now we're onto something as unemployment rose to 4.3% from 4.1%.
Unemployment is one factor, as the rise in unemployment triggered something called the Sahm Rule (don't worry I hadn't heard of it before last Friday either) that in theory predicts recessions. Interestingly the rule's author Claudia Sahm (video below) doesn't think we are in a recession but that increases in unemployment are concerning for the future.
To further complicate matters, remember that the Fed was actually hoping employment to cool down. To the Fed's eyes, a slightly higher unemployment number combined with a cooling inflation number would help confirm that inflation was tamed and that future rate cuts could be appropriate.
Next you had the Bank of Japan raising interest rates. What do interest rates in Japan have to do with our markets? In a nutshell, large investors have been borrowing Japanese Yen at low rates and investing them in currencies with higher yields (like the U.S.)
Another big headline was that Warren Buffett's Berkshire Hathaway sold one-half (about $84 billion worth) of their Apple holdings. Many took this as a sign that Buffett knows there is trouble around the corner and is hoarding cash. It should be noted that Apple is still Berkshire's largest single holding. So take that speculation with a grain of salt.
Lastly, the tech heavy Nasdaq is in correction territory having dropped more than 10% from its recent high of +24% to +11.5% today. Remember corrections typically occur every 12-18 months and are fairly common in both good and bad markets. In fact, only about 20% of corrections lead to bear markets.
So what does all of this all mean?
The Japan and Buffett anecdotes are relativity minor in my opinion and they are not indicative of the economy as a whole.
The Nasdaq correction is to be expected as a semi-regular occurrence for any segment of the market. The Index is still positive for the year and has been the best performing index over the past 1, 5, 10 and 20 years intervals.
The increased unemployment number and Sahm Rule do present some potential challenges, but again this higher level of unemployment was seemingly accomplished by Fed design.
Finally, to put this into bigger perspective, let's look at year to date returns through today Friday, August 9th:
As you can see, despite the recent volatility all indices are still in positive territory for the year. Corporate earnings remain steady, inflation is headed lower, GDP is solid. Unemployment is increasing, but this was also by design to combat inflation.
The moral of the story, corrections and volatility are both commonplace in the stock market and they don't necessarily mean we are headed for a recession or bear market.
So what's next? The Fed may finally lower interest rates as we've been expecting all year. I'll continue to look at earnings and inflation which should also give us an indication of the health of our economy.
Please take good care and let me know if you have any questions!
Until next time,
Steve