Is This The Big One (Financially Speaking)? Probably Not.
On Tuesday, August 25, PMC hosted a special webinar featuring commentary on the state of the markets and key takeaways for advisors.
Markets are going off a cliff, but economies and companies are still prospering.
There is only one question to ask on this manic Monday: Is the global market turmoil that now has spread to Wall Street a summer squall—a painful but ultimately transitory surge in volatility—or is it the first crack in a shaky global edifice that is crumbling?
First, let us give the naysayers their due. The argument that we should be very, very worried about what lies ahead is serious, and it deserves serious attention. The Dow Jones Index suffered its steepest losses since 2008. On Thursday and Friday alone, U.S. listed stocks lost more than $1 trillion; in the first minutes of trading on Monday morning, they lost even more. Global markets have been equally dismal. In the past month, another $1 trillion has flowed out of emerging markets, and China’s indices have seen double-digit sell-offs. Shares on the Shanghai exchange, not a real proxy for the China economy but real nonetheless, lost nearly 9% on Sunday night. German and French shares also lost 7% last week, and fell another 4% on Monday.
For some time, both pundits and professionals in market land have been on edge. They are unsure about when the Federal Reserve might raise short-term interest rates, and are uncertain whether the general global economic landscape is conducive to a further increase in corporate profits and stock prices. So the sudden sell-off, combined with the continued collapse of oil prices and the still remarkably low bond yields, has brought the doomsayers out of the shadows and onto center stage once more.
And yet. And yet.
The world has muddled through much better than the grim reapers of market land thought possible over the past years, and today, the global situation is arguably better than at any point in the past few years. The United States has managed steady growth, steady employment improvement, and even some signs of modest wage growth: Walmart is raising wages, and several cities are passing minimum wage laws. Europe not only hasn’t imploded, but also, aside from Greece is showing many signs of a nascent recovery, albeit with untenably high unemployment in countries such as Italy and Spain.
China is a wildcard, but is still growing at a robust pace. Further, the composition of that growth is likely of much higher quality than in the past: it's coming from a real middle class and domestic activity rather than exports and government spending. On Monday morning, the CEO of Apple, Tim Cook, made a bold statement about the strength of Apple’s business in China as a countersignal to the widespread belief that the Chinese economy is on the verge of imploding. And emerging market economies suffering from sagging oil and commodity prices invested heavily in education and infrastructure during their flush years. They also are, for the most part, ruled by democratic governments accountable for continued reform, even if some of those governments face glaring questions about past errors (such as the massive corruption scandals surrounding Dilma Roussef in Brazil).
And remember that larger companies remain immensely profitable and continue to grow at a rate well above that of most national economies. Although growth slowed in recent months largely because of the drag of energy companies, companies are—for better or worse—the most dynamic elements in the global economy. If any marginal rationality to the investing world exists, it makes sense that money will flow to them, and that the future of those investments is at least not bleak.
This sell-off may not be over, and further downside would hardly be a surprise. But the issue is whether this portends other pain and a long period of low or negative returns.
There are serious arguments that this is merely the first crack—the tremor before The Big One. One analyst wrote a long and thoughtful piece with the headline of "Dow 5,000? Yes it could happen". That would be a 70% decline and assuredly be part of a wider global sell-off that would obliterate tens of trillions of dollars of paper wealth. It would also be a steeper plunge than the one from late 2008 into March of 2009. But the ingredients are there: valuations are higher than 20th century norms; emerging markets that depended on a hungry China consuming raw materials are in a deep bind as that appetite diminishes and prices collapse; Europe and Japan are caught in a deflationary growth trap with shrinking populations and expanding safety net costs; China may be trying to transition from a manufacturing to a consumer economy, but it is clear that the export engine has stalled, and nothing yet has replaced it fully; and the United States is eking out low-level growth based on fewer workers, technology, and accommodative central banks.
This all looks bleak, but it is not the only picture. The bottom line is that for the past few years, financial markets have outperformed real-world economies. This year, many national economies are doing well while financial markets are either flat or down. The universe certainly can handle such a year, and investors should, too. The noise that negatively pervades financial commentary should not obscure the fact that net-net, much of the developed world has been rather stable, as has much of the world overall.
We have been in a period of extremely low volatility, and now we are reminded that markets are not always, or even usually, placid. This is a vital moment to communicate, to answer questions, and to explain the pros and cons of being more defensive or being more active. For the moment, this is a squall—severe sharp and sudden, but a squall nonetheless. It is imperative to monitor, but a bad time to act impulsively. The best opportunities often arise during these deep sell-offs, even as the risks appear higher. Stay tuned.
- This recent turmoil and volatility is a reminder that markets don't always go up or follow a predictable pattern.
- There are solid growth underpinnings in both the U.S. and global markets.
- While China has some issues, it is transitioning toward a consumer-based economy which could, over time, become conducive to that economy's prosperity and stability.