The weakness in China’s economy and the Federal Reserve’s idea of raising interest rates caused the initial decline in global stocks prices. However, not all stocks declined at the same rate. The current market environment reminds us that it is “a market of stocks” not just a “stock market.” What do we mean by this? During the last few weeks of market volatility, certain sectors and industries have suffered much worse declines than others – while a few sectors have held up quite well. Those investors who own a stock index or the whole “market of stocks” have experienced significant volatility and weakness during recent market declines, while those investors who have been more selective have experienced less of both. Investors should consider what this means in terms of the health of the overall market – as well as what changes should be made if this continues for an extended period.
The combination of China’s economic deceleration and a possible change in Fed policy has caused investors to doubt the longevity of the global expansion that began seven years ago. There is logic embedded in these concerns. China is the second largest economy in the world and many companies based in the US and elsewhere have been dependent on it for at least part – if not the majority – of their profitability. In terms of Fed policy, a move to raise interest rates has the effect of slowing economic growth. The possibility of slower economic growth or recession has negative implications for most economic sectors – such as consumer discretionary, industrial and technology sectors, to name a few. So it is not a surprise to see that these sectors are experiencing the worst declines during overall market weakness, as investors sell in anticipation of what could be much lower future profit growth. You may have noticed that we have been some of those “selling investors” and have reduced your exposure to these sectors over the past few weeks. The anchor in the current storm appears to be those sectors less reliant on economic growth, namely, healthcare, utilities and consumer staples such as food and beverage companies. It is in these more defensive sectors that your portfolio is now becoming more heavily weighted.
Over the next few weeks we will learn more about Fed policy, China and the health of the overall global economy. If current trends continue, we are prepared to become more defensive. However, it is also possible that data points turn more positive, in which case we will be actively re-investing in the areas of the market that we believe will provide the best recovery potential from what might just be a bigger than normal “passing storm.” We have been working diligently on a list of great companies to purchase should the clouds part and the sun shine through.
As always, we continue to manage your portfolio’s risk through your asset allocation (a bit more cash than usual at this point), your sector exposure (weighted more defensively) and the use of carefully placed stop loss orders. All of these tools are employed to mitigate the risk of catastrophic decline for your portfolio.
Recent market volatility can make most investors feel great one day and awful the next – try not to let it get the best of you! If you have any questions or have experienced any changes in your financial circumstances please let us know.
Sincerely,
Your Team at Main Street Research