Market Volatility – Our Thoughts

I would begin by saying Happy New Year but, unfortunately, in the financial world this new year has been anything but happy. US equity indexes are off to their worst start in history, with the S&P 500 Index down more than 8% since the ball dropped in Times Square less than 3 weeks ago.

Similar to what we experienced in late August 2015, we believe this volatility is a continuation of a technical market correction, and not a bear market. It is important to understand the stock market is not the economy, and the economy is not the stock market. You will likely hear rumblings of a “looming recession”, as the media tries to decipher each days’ volatility. This is understandable because, historically, markets have been considered a leading indicator of economic health.

The problem with that thesis is that times have changed. Today’s global markets are more correlated than ever, and (unfortunately) day-to-day activity is primarily dictated by speculators and short-term traders. Electronic algorithms trigger buy/sell programs, or large global institutions hedge commodities or currencies exposure, etc. Add some economic uncertainty, a little CNBC drama, and you get the fear-driven environment we have today. Bottom line: We believe there is a complete market disconnect from current economic fundamentals.

This is not to say there are not headwinds, or issues we are concerned about, and watching closely. However: The world is not ending, and I am confident this will pass. Markets will return to concentrating on actual fundamentals and value. We just need a little more clarity—hopefully pending corporate earnings reports will help.

I have been in this industry for over 28 years, and have seen this many times. It’s crucial to remember that most “investors” are not traders, and it’s important to filter out the noise. Never act on emotion, and maintain a disciplined, diversified investment strategy. Volatility and market corrections are normal, and very often represent opportunity—perhaps to put long-term money to work, take advantage of overreactions, or re-balance portfolios to meet future objectives.

Understandably, investors become nervous when volatility spikes like this. We are watching it closely and making adjustments to improve our investment models, where applicable. Below are our thoughts on some of the questions we’re hearing.

OIL – when will prices stabilize and at what level?

No one can say for sure, but when consider that Brent Crude Oil began dropping in June of 2014, when it was at approximately $115 a barrel. It closed this past Friday Jan 15, 2016 at $28.55; I have to believe we are close. There are already a lot of negative expectations priced in.

The general consensus among “experts” is that because of oversupply, expected additional oil from Iran, and the forecast of a continued slow down in China, there is a good chance oil prices will remain low for quite some time. It is important to note that there are many variables with a commodity like oil (i.e.; geopolitical risk, weather, etc.) and therefore, price forecasting is not a perfect science. Things can change, and often do, very quickly.

Now, let’s look at the positive side of lower oil prices. The media seems to enjoy focusing on the negatives, but while low oil prices impact energy-sector companies, let’s not forget the tremendous benefits lower fuel costs have to consumers, and companies worldwide that count fuel as an operating expense. At some point, extra cash in everyone’s pockets translates into increased spending on other goods and services.

In this recent market sell-off, fueled largely by dropping oil prices, think about this: Does oil have anything to do with the many sectors of our economy that are doing well? Sectors such as health care and pharmaceutical companies, telecom, software and technology, etc. The answer is not much, yet they have all dropped dramatically, in step with oil. Again, there is a disconnect from fundamentals, and for this reason we are confident the technical market event will pass.

How quickly—and by how much—will the Chinese economy slow, and what impact will that have on the economies of other countries?

The slowdown in China is not a new story by any means, and has been the main catalyst of the oil/commodity price collapse. Before the “great recession” of 2007-2009, China was the biggest purchaser of commodities and natural resources. For years, China fueled their internal economic growth by borrowing and increasing its manufacturing capacity.

Over the past few years, China has been transitioning from a manufacturing, export-driven economy, to a more internally-driven, consumer-based economy. This change has directly impacted all global industries that previously supplied those resources. China is the world’s second-largest economy, so this transition will take some time, but the end result should be a much more stable and balanced economy. It’s also important to note that just this past Tuesday, China reported real GDP growth of 6.90% (source: Bloomberg). That’s not exactly slow growth, by any standard.

While China’s economic changes have negatively affected global energy and commodity sectors (and the corresponding countries that supply China), how does that really impact the US economy? Actually, not that much. The real impact of China to US GDP is not as big as the media would have you believe. The US only exports approximately $120 billion worth of goods to China. This equates to only 0.7% of US GDP (As of 2014, source: World Bank).

What should you do right now?

Everyone is different, but the most important factor right now is the question of liquidity needs and investment time-frames. First, review your income and liquidity needs for the next year—if you know for sure that you will need a lump sum from your invested assets, then those funds should not be invested in the markets. I anticipate that we will continue to see increased volatility, both up and down. There is no reason to risk funds that you will need in the near term.

If your invested assets are earmarked for the future, and therefore have a longer-term time horizon, you probably should do nothing with regards to changes. However, you should still review the holdings with your advisor and consider re-balancing the portfolio so that you are well positioned to potentially benefit from the eventual recovery.

As always, the Premier Wealth Advisors team is here to answer your questions, and help guide you through this challenging period.

Wishing you and your family a very healthy, happy and peaceful new year

John L. Diaz, CFP



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