Thoughts on Recent Market Volatility

The past two weeks have been historically volatile in the stock market, with the Dow dropping 1900 points before recovering more than 900 points in the span of about two weeks. Monday was particularly stunning as the Dow lost more than 1000 points, before recovering almost all of its lost ground, only to lose almost 600 points within one trading day. The price swings have led some to conclude that we are on the verge of another bear market.

The recent volatility primarily arises from concern that the Chinese economy is slowing substantially. China is the world’s largest consumer of commodities and energy, so a slowdown there could further hurt the already beaten down commodity and energy markets. This will have an outsized effect on emerging market countries that export to China and have benefited from China’s growth over the past decade. Ultimately the fear is that because China and related emerging markets helped to kick start the current U.S. bull market, slowdowns in these countries can snowball and lead the U.S. equity market into bear territory. At the same time, the U.S. dollar is markedly strengthening against other currencies, as other countries try to devalue their currencies to stoke their economies. Nevertheless, the Fed likely will increase interest rates in the near future, potentially making the dollar even stronger and hurting U.S. companies that do business overseas. Combine all of these uncertainties percolating at roughly the same time and you have the recipe for a correction.

Despite the recent declines, we believe that the U.S. economy (and the U.S. financial system in particular) are much stronger than they were at the end of the last decade. The recent concerns over China and emerging markets do not change our perception of our country’s financial strength and ability to withstand weakness abroad. U.S. exports to China in particular make up a very small part of U.S. GDP so the strength of the Chinese economy has limited direct impact on our economy. Further, the last recession was caused by weakness in the U.S. financial system, which is the motor for the entire U.S. economy. While the current declines in commodity and energy prices are obviously a negative for stocks in those sectors, they ultimately can benefit consumers and other sectors of the U.S. economy. In other words, it is unlikely a recession would occur in the U.S. because of a collapse in energy and commodity prices that leads to a cascading financial meltdown, especially against a backdrop of a liquid, strong U.S. financial sector.

We do not take the recent concerns over China lightly, and we are wary of the negative impact of a stronger U.S. dollar on U.S. companies that do business overseas. But we believe these are company- or industry-specific concerns, not a reason for broad-based, long term declines at this point. We believe the U.S. economy is strong enough to withstand these headwinds and will not fall back into a recession in the foreseeable future. Without a recession, we do not see a return to the bear market of the late 2000’s. Of course we will continue to monitor the situation closely.

Our philosophy as long term investors is not to panic and sell indiscriminately during market corrections. We view day to day market movements like the ones we’ve seen recently as buying opportunities for blue chip companies that are temporarily on sale, and we recently have added to some positions that became values given the significant declines. We believe that patience, proper portfolio diversification and knowledge of our client’s financial goals are the keys to long term success, and daily and even monthly moves are background noise over a long term investment horizon.