And we’re off…by about 6%! The first week of trading in 2016 claims the honor of being the worst starting week on record for the S&P 500 Index in its long and storied history! The US headliner dropped by 5.9% while the tech-heavy Nasdaq was off by 7.3% and the Russell 2000 benchmark of small cap stocks sank by 7.9%. Our global benchmark for the stocks category, the MSCI All Country World Index, fell by 6.1%, settling near the lows registered back in September. As Gene Peroni said in the opening quote, it was a rough week!
The first domino to drop last week was China. Before US markets had even opened on 2016 Chinese stocks had already fallen by 7.0%, triggering an automatic circuit breaker that halted trading for the day. Such a circuit breaker, which pauses trading for 15 minutes if the market falls by 5% and halts it for the rest of the day if it falls by 7%, is intended to protect against computer driven flash crashes and panicked selloffs. Throwing a circuit breaker is not a great way to start the year. Throwing it for a second time just three days later (yes, it happened again on Thursday) is even worse. Oh, and the date this circuit was first introduced into Chinese markets? Last Monday. Chinese authorities would ultimately “suspend” the use of the circuit breaker after Thursday’s crash, pointing to the possibility that its very existence was leading to frenzied selling and thus acting as a self-fulfilling prophecy.
There are a couple fundamental reasons which led to the volatility in China. Over the New Year’s weekend, the Caixin Purchasing Managers Index (PMI), a strength reading on China’s manufacturing sector, came in weaker than expected and declined for the 10th month in a row. This whipped up a flurry of concerns, none of which are necessarily new, over the underlying strength of China’s economy. The second reason, which is interlinked with the first, is related to the Yuan. For two years now the Chinese have been weakening their currency vs the US Dollar in an effort to improve their manufacturing and exporting position since a weaker Chinese currency makes Chinese goods relatively cheaper to other countries. One side effect of a weakening currency, however, is that assets denominated in that currency become less attractive to global investors. The weak manufacturing data, therefore, led to anticipation of more Yuan weakening which in turn led to a flight of capital out of Chinese securities.
It’s also worth noting that oil continued to make headlines last week. Remember during the financial crisis when oil prices sank like a rock from nearly $150 all the way down to roughly $30? Following that collapse the overwhelming consensus was that oil would never again touch those lows. Well, that’s exactly where we are now. As I write this post, oil prices are actually below their closing lows set in early 2009. This price decline is being driven almost exclusively by an oversupply in the market (obviously not by peace in the Middle East), as output from OPEC, the US and other major suppliers has yet to show any signs of tapering off despite a clear decline in global demand.
So what is the point of all this? To be frank, one week is a relatively meaningless amount of time in the grand scheme of things, and we would normally resist the temptation to call attention to such a brief period. That said, we felt this was a good opportunity to share, yet again, our views on what to pay attention to, how to digest information and how to prudently manage money amidst it all.
First of all, let’s not forget that each day brings its own set of worries. A potential slowdown in China and weakening oil prices are not new developments by any stretch of the imagination. Neither is a 6% pullback in the stock market. We have to take these things in stride and view them in the broader context, as occurring on a global theater and within a continuum of past and future events. In other words, nothing happens in a vacuum and we need to resist the temptation to amplify any singular data point in our mosaic of understanding.
Secondly, realize that our media outlets are structured to deliver quick, immediate answers. Clear explanations. High conviction predictions. Careful, thoughtful analysis, which typically requires long periods of digestion and processing, has been replaced by shallow, real time soundbites. And most of these play to the psychological draw of being negative and frightening. The fact of the matter is that no one can fully explain why the winds of thought, emotion and circumstance shift the ocean of human financial market participants marginally in one direction or another on any given day. And if you’re committed to a long-term financial plan and a disciplined investment strategy, guess what…it doesn’t even matter.
Which brings me to my final point. None of this means we can sit back, throw up our hands and be complacent. That’s not at all what we’re suggesting, and in fact it’s quite the opposite! The reality is that we need to work as hard as ever, but we need to focus our efforts on what we can control and where we can have impact. As it pertains to the investment portfolio, what this looks like for us is allocating your money across a variety of strategies that will work together in a systematic, disciplined manner over a long period of time to meet return expectations while simultaneously protecting capital against substantial drawdowns. While large macro trends will always play into the slow shifts we’re making in our allocation strategy, reading the economic tea leaves on a day to day basis does not even enter into the process.
We feel fortunate to currently be on a 100% cash signal in MarketVANE STOCKS. What this means is that, aside from a handful of one-off holdings, we did not participate in last week’s stock market decline. This wasn’t a gut call on our part, but was a result of following a well-defined, systematic approach to managing downside risk in our stock portfolio. Whether or not this cash signal ultimately adds value still remains to be seen (see The Babe Ruth Effect), but for the time being we’re remaining in this defensive position.
We come into the office each day and work extremely hard for you, our clients. Our hope is that our efforts pay off by empowering you to feel the freedom to pursue what makes your life truly rich. The New Year is off to a rough start for the stock market, but this doesn’t change anything for us and we hope it doesn’t for you, either.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.