We doubt very much that Federal Reserve Chair Janet Yellen reads our Strategy Updates. However, their inaction today suggests that we are all on the “same page” in terms of the negative impact that higher rates would have on an already slowing global economy. As we discussed in August, the combination of China’s slower growth and the Fed’s unwavering intention to raise rates could potentially increase the odds of a significant economic slowdown or possibly a recession. Historically, equity markets decline significantly during recessions and the recent 13% (more than normal) decline during July — August may have been the precursor. Now that the threat of an interest rate hike has been removed (or at least delayed) will the bull market resume as before? Our answer is yes and no.

The Federal Reserve sent an important message today. The weak and wobbly global economy — to which the US is significantly linked — is not strong enough to withstand any headwinds which higher rates would create. The Fed is also concerned about financial markets and both consumer and investor confidence. Given these concerns, it is important that investors adjust to this changing environment, which we have already done. The Fed’s retraction of raising rates does not mean that the risk of the economy slowing has been removed and, given that the bull market and economic expansion is now in its seventh year, there is always a chance that softening economic growth turns into something worse. It is during these periods that investors would be wise to follow our lead by reducing equity exposure and refocusing their remaining equity exposure on companies that we believe can grow their profits regardless of economic strength or weakness; namely companies in the healthcare, consumer staple and utility sectors. We believe that these companies are inherently more defensive, yet generate profit growth in a slower economy and can potentially be very profitable for investors. Recent market volatility has favored these sectors and companies and, until there is a significant increase in economic growth, we see no reason why this will not continue.

Now that the Federal Reserve has recognized that the global economy is not ready for a rate hike, we only need a few more data points to encourage us to become less defensive. China’s growth rate stabilizing and better than expected corporate earnings reports would be very helpful. We will be keeping a watchful eye on these and other signs of a return to stronger growth.

At this point there are two potential risks we face as investors. (1) The risk of the stock market as a whole rising dramatically during our more conservative posture; and (2) the risk of the stock market falling significantly lower than the recent bigger than normal decline. At this point, we believe the risk of the first is marginal and, were that to occur, we could quickly become more growth oriented. We have already begun to address the second risk by reducing your equity exposure and adjusting it in a more defensive manner. Should markets get tougher, we will continue to manage your portfolio’s risk through your asset allocation, sector exposure and carefully placed stop loss orders.

It is an uncertain global economy and our team is looking for great investment opportunities to assist you in growing and protecting your portfolio. 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