Week In Review – 02/01/2016Bruce Doole
February 1st, 2016
Five Reasons Not to Panic Over the Markets
The S&P 500 Index has fallen by more than 8% in the first three weeks of 2016, and international markets such as Japan, China and the U.K. have fallen into bear market territory.
1. Collapse of energy and commodity prices. Energy and other commodity prices are severely distressed, with no turnaround in sight. However, energy is a relatively small contributor to the U.S. economy – with U.S. energy companies accounting for about 6% of the S&P 500, and oil and gas extraction employment less than one-eighth of 1% of total non-farm employment. We don’t see the downturn in oil and other commodity prices as a catalyst for another crisis for the U.S. economy. Falling oil prices are an economic nightmare for the governments of Russia, Venezuela and Saudi Arabia, but are good news for oil consumers throughout the world.
2. Slowdown in China. The symbolic impact of China’s slowdown is taking on outsized importance relative to the actual impact on the global economy. We expect the industrial slowdown in China to continue, creating challenges not only for China but for commodity exporters throughout the world who previously benefited from China’s seemingly insatiable appetite. The Chinese government has substantial financial resources and powerful motivation to keep their economy from falling into too steep a slowdown.
3. Bank health. U.S. banks are stronger than was the case in the prelude to the financial crisis, more than doubling equity capital since 2009 while significantly improving credit standards. European banks have made less progress, but are still stronger than they were at the depths of the European sovereign debt crisis.
4. Residential real estate. Real estate, according to BCA Research, represents half the share of GDP that it had in 2005. There is considerably less real estate-related leverage in the system, and delinquencies are not signaling a return to the systemic stress experienced in 2007-09. Although there may be some pockets of excess, real estate doesn’t seem to be a threat to the health of the U.S. or global economy.
5. High yield. The high yield market has been under pressure alongside falling oil prices since 2014, pressure that increased since the closing of Third Avenue Management’s distressed debt fund. Delinquencies and defaults are rapidly increasing among energy and commodities companies, but the rest of the high yield market is experiencing much lower levels of financial stress. In stark contrast to the collapse of the housing market in 2007, most high-yield debt is owned by non-leveraged investors and the derivatives structure that served as an accelerant to the financial crisis in largely absent from the high yield market.
Overall, we think economic conditions will continue to provide a backdrop of slow growth. Despite negative headlines from recent weeks, there are significant bright spots in the global economy. The employment picture is significantly improved in the U.S. and in Europe, monetary policy is still relatively “easy,” and fiscal austerity has eased in most countries. Despite contraction in the industrial economy, the services sector continues to be healthy in both the developed and developing world. We think this backdrop supports a slow, but still-growing global economy.
Sentiment often swings between extreme optimism and extreme pessimism, and emotional swings are often disconnected from fundamentals. In our view, the plunge to start the year is more a function of sentiment than of an impending crisis in most of the global economies.
Do your best to step away from the constant flow of headlines to distinguish between noise that distracts you and news that truly changes the outlook for your investments.
– Source: Think Advisor, by Daniel Kern
– Source: Ivy Funds