PMC Weekly Review - October 23, 2015

A Macro View – Strength in October: The Correction-Bounce Rally

Kicking off the fourth quarter, the market has experienced a strong rally off its double bottom lows of August and September. Momentum has driven most of the recent gains.  This week, Technology companies, including Amazon, Microsoft, and Alphabet (Google’s new parent structure), posted blow-away earnings. And several companies announced major share buybacks, continuing the trend of recent quarters, and helping to boost investor sentiment. The market has reversed course quickly from the selling pressure we felt in August and September, causing many to forget that the August decline was the worst August the S&P 500 has experienced since 2001.  

In reviewing the current Q4 momentum-led rally, it is important to pause and reflect on the reasons that led to the late-summer volatility and selloff. In August, reports of devaluation of the Chinese currency and a fear of its weakening economy led widespread equity selling, which continued through much of September. Fears of a slumping global macro environment were one of the reasons why Janet Yellen and the FOMC held off its highly anticipated interest rate increase at the September meeting. These macro developments, coupled with investors’ concerns that a rally that had run out of steam may have created a market top, led to the S&P 500’s first correction since 2011, plunging as much as 12.5% off its record high.

Market bulls have returned the past few weeks—so have global economic slowdown fears been quelled? Are we completely out of the proverbial bear market woods? One should remember that as recently as Monday, China reported GDP growth for the third quarter at 6.9%, its worst reading since early 2009. A slowdown in China not only affects emerging market economies but also growth throughout Europe and the United States. Aside from China, bulls may be discounting some other concerns as we approach year end.

The market recently has focused on global economic developments, but investors should understand some domestic concerns as we begin the last few months of 2015. First, the U.S. debt ceiling will be completely exhausted on November 3rd, and Treasury Secretary Jack Lew has been pushing Congress to raise the limit to fund our current debts. In 2011, the debt ceiling debate led Standard and Poor’s to downgrade the U.S.’s credit. And in 2013, the Treasury came close to missing payments.  Both events led to heightened volatility. Second, and more widely discussed, is the possibility of a FOMC rate hike at one of its two remaining meetings this year. It’s a difficult decision for the Fed.  Economic data has been mostly mixed: consumption numbers are solid, but data indicates manufacturing and employment are struggling. These domestic worries should give the Fed further room to hold off until early 2016, but the potential for a rate increase lingers, and leaves the door open to more volatility before year end.  

In the face of these looming anxieties, investors may be best served by exercising caution before jumping back into a market that has bounced rapidly off its correction lows. A slowdown in China, the looming debt ceiling deadline, stretched equity valuations, and an eventual FOMC rate increase are all valid investor angsts. Despite them, investors who fear missing out on further upward momentum have pushed stocks back into positive territory for 2015. However, with the August/September selloff clearly in our rearview mirror, we are looking at this market through a more cautious lens. Recent market gains may be a precursor to an early Santa Claus rally, but we prefer to view the current developments and market reaction with a level of measured skepticism.   

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