It’s contagious! Fear continues to spread causing equity markets globally to further retrace gains made this year and last. Fear that the Fed will raise rates too quickly and choke off the domestic recovery. Fear that the US Dollar has risen too fast and will reduce economic growth further. Fear that the European Central Bank (ECB) is powerless to revive the growth and price stability of Europe. Fear that oil’s slide speaks to a fundamental shift down in demand from Europe, Emerging Markets, and the US and threatens the investment made to increase production. Fear that traders can’t pinpoint exactly why equity markets have declined these past few weeks and, thus, they fear to be too late to get out. Price action in the equity markets shows the confusion of traders from one day to the next. The S&P 500 gave up 30 points on Tuesday (around 1.5%) just to get them back on Wednesday and then drop them again on Thursday. The so-called “fear index” (VIX index measuring the implied volatility of the S&P 500) has bounced higher and is now over 19 from the unusually low reading around 11 a few months ago.
From our standpoint, these jitters are normal in the larger scheme even if they have been less frequent these past few years. Fundamentally, we believe the Fed will be slower than expected to raise rates for several reasons. Janet Yellen is a “scientist” and will wait for inflation and employment data to tell her it is time. US inflation data is likely to weaken due to the understandable increase in the US Dollar and the decrease in energy prices. While the US Dollar increase will be a headwind at the margin for growth, the positive impact to personal consumption as energy prices fall will likely counterbalance. The decrease in value of the euro will be supportive of that region’s growth as over a quarter of their GDP is based upon exports which are becoming more competitive. In looking at energy prices, the decline to $85 a barrel is not outside the range of expectations since US production continues to grow and the feared supply disruptions from geopolitics (Russia, Libya, etc) has not materialized. While it is early in the Q3 earnings season, so far sales and earnings have exceeded expectations particularly in the cyclical sectors. Seasonally speaking, October has historically been a challenging month (especially in a US mid-term election year) and it has been sometime since the equity market has taken a breather. The magnitude of the retracement varies by geography and capitalization – equities outside the US and lower in capitalization taking the brunt. We continue our patience, maintaining confidence in our core themes and looking where price declines have been biggest. We are looking for opportunity that, with a long-term perspective, will benefit portfolios.