Equity markets sold off in dramatic fashion beginning Thursday, August 20th
. The Dow Jones Industrial Average (Dow) lost about 1,000 points in two days to end the week. It didn’t get better over the weekend as on Monday August 24th
the Dow was down over 1,000 points in early trading. While the largest single day drop in the Dow occurred on October 19, 1987 (-22.6%), the past three trading days rank as some of the most volatile in market history. We believe the magnitude and speed of the selloff is due to structural weakness in the global economy ignited by China, as well as ineffective central bank policies of near-zero interest rates intended to stimulate growth. This has led to higher asset prices that may not accurately reflect valuations of current equity securities.
While China may not be the sole reason for structural weakness in economies across the globe, its 8.5% stock market drop (Shanghai Composite Index) on Monday sparked a global sell off in markets. As the world’s second largest economy and a major consumer of commodities, it has an effect on the global economy. China’s growth outlook is not as healthy as once expected. Last week China’s central bank devalued its currency, the yuan, in an attempt to improve its trade balance and spark growth within their economy but the Shanghai index continued to struggle. Then, over the weekend, China’s central bank announced plans to flood their banks with liquidity to offset their recent currency devaluation.
Central banks in the U.S. and abroad have contributed to the current market volatility. The Fed lowered the fed funds rate near zero after the financial crisis with the hope of spurring businesses to borrow cheaply, grow their business, create jobs, and improve the U.S. economy as measured by Gross Domestic Product (GDP). Other central banks around the globe also implemented similar programs. In reality, some would argue that lower rates and continued Quantitative Easing did not provide the intended effect to kick start the economy. These policies may have led to inflated prices and overvalued markets. The PE (Price-Earnings) ratio of the S&P 500 is currently about 21
, and we believe that company earnings reports are not supporting this high of a PE. Economic growth has been and, we believe, will continue to be sluggish.
What does all this mean?
In our view, while the magnitude of the recent market downturn may feel like a Band-Aid being ripped off instead of a slow correction, the pain may continue. At current valuations, slow growth prospects, and few tools left for central banks to utilize, the equity market may continue to slide further.
Where will it bottom?
While no one knows how far or when the slide will end, it will continue until it reaches a level where more investors feel price valuations are attractive and more in-line with earnings potential.
What should an investor do?
Markets are cyclical and we believe that volatility will continue. Therefore it is imperative for investors to understand their risk tolerance and review their portfolio to ensure they are diversified appropriately.
Our Investment Services team can help identify investments and portfolio allocations that are in line with your retirement plan goals. To learn more, please contact a Pension Consultants Investment Consultant at 800-234-9584
or email us at firstname.lastname@example.org
P/Es & Yields on Major Indexes – Markets Data Center – WSJ.com. http://wsj.com/mdc/public/page/2_3021-peyield.html
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