January 4, 2016 – The Dow Jones Industrial Average is down more than 400 points as we write. What happened with the change in the calendar?
Did retail sales fall? No.
Is the housing sector collapsing? No.
Was there a decline in manufacturing? No.
The only “news” overnight was a sizeable drop in Chinese stock prices that triggered recently implemented (in September) circuit breaker rules (i.e. trading halts). So let’s examine that a bit more.
What was the cause of the drop in Chinese stocks? A closer look reveals manufacturing figures released overnight that were down slightly, but not remotely catastrophic. Furthermore, the drop in economic data did nothing to change the narrative for China. The country remains stuck in this lower-growth environment (relatively speaking – it’s still growing faster than the US, Europe or Japan), and has been in this state for several years now. So the answer to the question is not a change in economic conditions.
A deeper look reveals that the Chinese market appears to be suffering from the same factors that weighed on it over the summer: currency uncertainty and policy concerns. The bad news is that those are notoriously short-term and unpredictable. The good news is that what really matters to stock markets in the long-term are fundamentals (i.e. how the economy is doing).
The Chinese economy appears to be relatively stable at this point, and although the manufacturing sector is not growing, it is also not significantly shrinking. The transition from an export-driven economy to a consumer-driven economy is taking shape (the Chinese services figures out this morning were good), which is a good thing. For those reasons, we remain optimistic about the long-term fortunes of China.
So let’s bring it back to the US. Why does a drop in other stock markets affect the US stock market? Often, the answer is usually some derivative of a “contagion effect” – meaning when one area of the world sneezes, other areas catch the cold. When that argument doesn’t work (as is the case here), it is usually the product of a “sympathy trade” – meaning when one region/sector becomes more volatile, investors in other regions/sectors also get nervous and pull back on exposures.
In times like these we acknowledge that market swings can be scary, but just as we experienced with the volatility in late summer we use opportunities like this to re-balance, review asset allocation and encourage investors to remain disciplined. Volatility happens. Sell-offs happen. But those who abandon their strategy never experience the subsequent bounce-back. As always, we are here to help you in any way we can, especially during nervous times like these.