While the recent volatility of U.S. stock markets is a concern, perhaps one of the most remarkable things about the steep nosedive in the Dow Jones average February 27 is how much it was taken in stride. That may be because upon analysis, many investors felt the reasons for the sell-off, including a computer glitch and over-reaction to the decline in the Chinese stock market, weren’t cause for long-term concern.
Ashby Foote, president of Vector Money Management Inc. Jackson, said anytime the Dow Jones average drops 500 points is a good time to pause and reflect.
“The stock market is a great barometer of the economy, but even big indexes like the Dow Jones or S&P 500 can sometimes make knee-jerk reactions that in retrospect prove to be over reactions,” Foote said. “The first thing I do is check indicators outside the stock market for any signals that there is trouble ahead. My current assessment is that the economy is very sound. The consumer is in great shape. In fact, the consumer confidence number that came out this week is the highest in five years. And tax revenues at the federal level are exceeding everyone’s expectations, which has shrunk the deficit faster than anyone had projected.”
Foote said that overseas the developing economies are enjoying the best growth conditions in memory. One of the catalysts given for the recent stock sell-off was a 9% drop in the Shanghai market, but it is important to note that that same index was up 16% in the prior three weeks and is up more than 150% in the past two years.
“Developing country stock markets are notorious for wicked swings up and down,” Foote said. “That is just the nature of rapid-growth economies. China is a crucial part of today’s economic landscape, but there is little evidence of any material slowdown from China that would show up in commodity prices, all of which are little changed in the past several weeks and many of which are still close to all-time highs.”
One dynamic that has changed over the past five years with the stock market is the influence of hedge funds and their off-shoots, “funds of hedge funds.” Foote said this latest ramp in volatility may well be related to some hedge funds that got over-leveraged and out of synch with the market.
“It wouldn’t be the first time, and it surely won’t be the last,” he said.
Bigger, longer perspective
Scott Reed, CEO of Hardy Reed Capital Advisors, Tupelo, said in addition to concerns about a cooling economy and declines in the Chinese stock market, another reason given for the decline was that a suicide bomber got too close to the vice president in Afghanistan. Instead of looking at the reasons that sparked the large one-day decline, he prefers to look at the long-term, big picture.
“That is that we are in the middle of the second-longest bull market without a 10% correction in our history,” Reed said. “If you look at the market from the beginning of the correction in 2000 to date, it is reasonable to assume that we still have some significant upside for the bulls.
However, a shorter look of three years or so would indicate a need for a breather. The correction was a mini-breather. I never know what events are going to trigger a breather in a market that is running fast. The three issues listed above are as good as any, but it is not hard to understand why it would happen. For lack of a better, more sophisticated analysis, it was time.”
Should investors do anything with their portfolio based on the recent decline in the market? Reed said he can’t answer that question for everyone because each person has different objectives and goals.
“However, I can say that, in general, long-term portfolios shouldn’t change based on the daily fluctuation of the market, and so far that is all we have had,” he said.
Stacey Wall, president and CEO of Pinnacle Trust, also said that the decline was a “panic reaction” that, upon close examination for the reasons behind the decline, was not justified.
“The Chinese market fell 9% in one day,” Wall said. “That kind of got it started. But the reason the Chinese market fell is because their governing body came out and said they were going to crack down on illegal trading and speculation, which does go on. They aren’t as regulated as the markets are in the U.S. What gave us comfort is that we believe the fundamentals behind the big market advances in China are still very strong. If we had some concerns fundamentals were deteriorating, then that would be a lot bigger deal.”
Wall said the other event that pushed the decline along was a computer glitch in the U.S. market that made it appear the U.S. market fell approximately 200 points in approximately two minute.
“That is very severe,” Wall said. “That caused some additional panic in selling. After the fact, they realized it was a computer glitch that caused that rapid decline.”
Wall has been warning for six months that the market was overdue for a correction in stock prices. He said it is unusual to go so long without a correction.
“We were overdue for something like this to happen,” Wall said. “The market has done great for the past four years, and that is a pretty long run without getting a pull back. So while we are somewhat cautious at this point, we believe the weight of the evidence still does not indicate that this bull market is over. Longer term projectors we use are showing the possibility of running into some trouble in the fall. That is not always 100% accurate because we are going so far out. But at this point, baring any unknown event like a terrorist attack, that is probably when we feel we may have some downside risk.”
Wall said he feels very good about the international markets in terms of stock. Their long-term uptrend still looks very solid. He said there is a good chance gold will resume its uptrend, and so that would be a good play, too. He also expects other commodities like oil will resume uptrends shortly.
Some financial analysts have warned that China’s stock market decline could spell real trouble for the U.S. The huge U.S. trade deficit with China is a major concern.
“Those types of things are long term and major, and they could be very well be dangerous in nature,” Wall said. “But they tend to be so far out that it is tough to make any predictions today as to when that could have an adverse effect on our stock market. It could be years. But it is not a good thing.”
‘Made in China’
James Trippon, editor-in-chief of the China Stock Digest, says a big part of America’s financial future is already “Made in China.”
“I’ve been running around like Paul Revere shouting ‘The Chinese are coming!” Trippon said. “Now it has finally affected the market. China is on track to become world’s largest economy in 10 years. The U.S. economy is worth about $11 trillion annual and China’s is worth $8 trillion. The thing about China is that, in the past 10 years, it has grown at four times the economic rate of the U.S.”
For a long time it has been said is the U.S. economy caught a cold, the rest of the world would get the flu. Trippon said the way it is developing now, if the Chinese economy is under the weather, the U.S. is going to be the one with Asian flu.
“They are not a small economy anymore,” Trippon said. “As far as market pullback, that will work itself out. But this is really the first clear indication about how much impact China is going to have for the U.S. economy.”
Trippon said a severe recession in China could spell economic disaster for the American economy and American investors. It may even decide the next presidential election.
“China’s low labor and manufacturing costs have propped up the American economy for years,” Trippon said. “A disruption to Chinese capital markets could create a disaster for China’s economy. That in turn would affect the cost of consumer products in the U.S., the value of the dollar and the financial future of millions of Americans.”
For the past 10 years, the U.S. has had a low inflation rate. Trippon said everyone thinks it’s because Alan Greenspan was such a genius in his role as Federal Reserve chairman.
“What few people realize is the low inflation rate had a lot more to do with all manufacturers in China paying laborers $1 to $3 a day,” Trippon said. “That is what has kept prices in the U.S. artificially low. Say China gets into economic problems, the banking system weakens, and Chinese manufacturers can’t get as much credit as they have had. Then they would have to raise prices, which would spike U.S. inflation.”
Trippon said it may take a few years to see it, but wage rates for Chinese workers will grow. And, long term, that will have an impact on U.S. inflation.
Finding a way to profit?
Regarding advice for investors, Trippon said those who sell whenever there is a major market decline usually get burned. He says the other side of the equation is that the market correction has resulted in a some bargains both at home and in China.
“Some of the best blue-chip companies in China are now trading at ridiculously low prices based on U.S. valuation standards,” Trippon said. “Our viewpoint is if you can’t change this major economic trend, why not find a way to profit it from that? And that is what we all about. We are unabashed capitalists. We are trying to benefit from what is going on now.”
Contact MBJ contributing writer Becky Gillette at email@example.com.