September 9, 2015
Today we're publishing an article written last week by Brennan Redmond, CFA; a Senior Vice President of Brighton Securities. Brennan's piece is particularly timely given the market's volatility, though his opinions should not be taken as personalized investment advice for you. We always advise consulting with your own Financial Advisor about your specific investment objectives and strategies before taking any action.
It was a boring year for the markets. Then August happened. Markets tipped steeply into the red, delivering the first 10% correction for the S&P 500 and the Dow in four years. Affects vary between uncomfortable and frightening. Investors have been enthusiastically hitting the panic switch, with computer-based trading exacerbating the sell-off. The question we are all asking ourselves is: "is this the beginning of a repeat of 2008/2009?" In my opinion, that scenario is highly unlikely for three important reasons.
First, the sine-qua-non of this correction is a slowdown in Chinese economic growth. But the financial media, well aware that bad news attracts more eyeballs, have been playing this up while neglecting several important points. First: sales to China represent a mere 0.7% of U.S. GDP; only 2% of sales generated by S&P 500 companies come from China; and less than 1% of U.S. exports end there. The potential ripple effect on our economy is not nearly what the press has made it out to be. Second, slower Chinese growth means less demand for industrial commodities and materials resulting in lower prices for each. As net-consumers this is unequivocally good for our economy. Third, as one of my favorite economists, David Rosenberg, has pointed out, Japan was the world's second largest economy from 1968 through 2010 (when China overtook that mantle). For the past twenty-five years Japan was in recession approximately 40% of the time. During most of that time the U.S. was experiencing a robust economic expansion and bull-market. Further, the recessions of 1999, 2001, and 2008 had nothing to do with Japan. Thus the notion that China is going to derail our economic expansion and bull-market is dubious at best.
The second reason recent volatility is unlikely to turn into a major market rout like 2008/2009 is that nearly every central bank around the globe is trying to stimulate inflation through the "wealth effect". The wealth effect is best summed up as any change in spending that occurs due to a perceived change in wealth (a theory of admittedly dubious efficacy but since when, in government work, do results matter more than intentions?). The practical implications of this are that central bankers pay very close attention to stock markets and will adjust policy in response to market weakness. For this reason far fewer professional investors believe that the Federal Reserve will now begin raising interest rates in September. It's a truism in the markets that one should never "fight the Fed"; and in this case the Fed wants a rising stock market. There's no good reason to believe that after all the Fed has done over the years that they are willing to reverse course now.
The third reason this correction is likely to prove fleeting is that the U.S. economic backdrop is positive. The second-quarter GDP figure was recently revised up to 3.7%, a very good number. Hiring seems to be robust; business investment is up, etc. etc. There is also little reason to believe the economy will suddenly nose dive for two reasons: interest rates and energy prices. Every recession since the Great Depression has been tipped off by some combination of those two factors. And right now neither of them is anywhere near ominous.
So what should we do? My suggestion, lean in! Use this latest tantrum to your advantage by picking up stocks whose yields are suddenly much more generous. Let's briefly revisit the rationale for owning dividend payers. First, the income is generous relative to most alternatives available. Second, dividend income is one of the best hedges against inflation over the long term (dividends are far more often increased than they are decreased). Third, dividend stocks tend to have lower risk as a portion of the return is not speculative thus providing meaningful downside protection. The recent tantrum has also pushed bond yields lower. In my opinion, the opportunity now exists to rotate out of bonds and into dividend paying stocks at favorable prices for both; investors can get better income from stocks than from bonds, as well as long term growth potential. In return all you have to do is tolerate volatility.
Brennan R. Redmond, CFA - Senior Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)