Are the Markets Waxing or Waning?

Both a lunar eclipse and a super-moon made for a dramatic celestial show on the evening of the final Sunday of September. A super-moon occurs when the moon’s orbit brings it closest to Earth, and a lunar eclipse leaves the moon with a rusty, reddish color.

It’s interesting that only theories explain the creation of the moon. The most commonly accepted theory is that another planetary mass that orbited our sun collided with Earth long ago, and the collision sent pieces of Earth and the other planetary mass into orbit around the Earth, eventually forming the moon. There are obvious ways the moon affects the earth, such as how its gravitational pull causes our ocean tides. There are subtle effects from that ancient collision, like how it caused the Earth to slightly tilt on its axis.  Regardless of the moon’s origin, there is no arguing that there is a distinct relationship between the planet we call home and that pale white, barren body orbiting us day after day.

Delaying the Inevitable

Probably the biggest news from the month of September was the Federal Open Markets Committee’s (the FOMC or the Fed) decision to leave the Fed Funds rate unchanged… for now. Possibly the most interesting aspect of the Fed’s announcement came in this line from the FOMC’s official statement:

Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.

The Fed has led the general public to believe a number of different things about the eventual path to “normal interest rates.” First, their decisions would be data dependent. Second, rate hikes would start small. Third, the journey to “normal interest rates” would be a slow one.  And ultimately, interest rate hikes would occur when the economy was healthy enough to both warrant and weather them. Well, now the Fed has added another condition: global economic conditions and global markets. The Earth and moon are not a perfect analogy for the relationship between U.S. and global economic growth, but obviously the Fed thinks that foreign issues have enough effect on the U.S. that they should play a part in dictating the Fed’s central banking policy decisions.

The Fed believes that, while inflation is currently low, it should soon move back to normal levels. The Fed also believes that employment has been improving, although wage inflation leaves them wanting.  The Fed now finds itself in a very tough spot. The current strength of the U.S. dollar (USD) makes a rate hike a tough call, but economic data looks good enough to make you wonder what else the Fed needs to see to go ahead and start raising rates. Rates have been near zero for six years, but the Fed is letting on that a rate hike will find its way into the last few months of the year.  Time will tell.

Land Under Heaven

No one knows where the name “China” originates from exactly, but some think it might be a rough translation or mispronunciation of the word “tianxia,” which means “under heaven.” Tianxia is an ancient Chinese cultural concept that explains, in part, how the vast lands of the Asian continent were appointed to the Emperor to rule and to apply social and political order. Right now, there appears to be a real lack of financial order in China as Chinese stock markets continue to decline.

It is debatable whether the Chinese Yuan devaluation was the cause of or the excuse for the global stock market sell-off, but there is little debate that the devaluation was at least a major catalyst. Many saw the devaluation as an admission to the world that China’s impressive economic growth engine was finally slowing.  As the second largest economy on the planet, China certainly matters. Manufacturing and factory reports published in September showed weak numbers and industrial profits have fallen nearly 9% year-over-year. China will continue to do all that it can to promote domestic growth, but the Chinese will have to do a lot to inspire confidence in its faltering economy.

Two other emerging market countries are also floundering.  Russia’s economy continues to deteriorate at a rapid clip.   Energy constitutes 70% of exports from Russia, so it should come as no surprise that low oil prices are having catastrophic effects. It’s been estimated that roughly 22 million Russians, more than 15% of its populace, now live in poverty.  Russia was slapped with tough economic sanctions by the international community due to its role in the crisis in Ukraine. Those sanctions have really hurt, leaving Russian companies unable to raise money in Europe, sell arms around the world, and have less restrictive access to oil drilling technology. And a friendly trade relationship with China is not helping much as the Chinese have been unable to deliver on promises to purchase commodities from Russia as originally anticipated due to China’s own lack of economic growth.

The second stumbling country is Brazil, whose sovereign debt has slipped from investment grade credit rating to “junk” status. Huge budget deficits were the primary reason for the most recent credit downgrade. However, Brazil’s economy is also plagued with bureaucratic red tape, poor infrastructure, and a currency too strong to serve as a tailwind for stock prices. Falling commodity prices have also played a part as Brazil is a big exporter of both oil and iron. General weakness in emerging market economies are leading to questions about their impact on developed economies.

Displacement

Developed Europe is also dealing with a myriad of issues. Falling prices and the risk of deflation are real problems as Europe continues to struggle its way out of recession. Unemployment is still a prominent issue in many countries, notably Greece, Spain, Italy and France. The Eurozone, on the whole, has about 10% unemployment with Germany posting the lowest unemployment rate on the continent.

One of the biggest issues that the Eurozone is currently dealing with is the influx of refugees from Syria, Iraq and Libya, where residents are fleeing their war-torn homelands by the tens of thousands. The United Nations estimates that 60 million people worldwide have been displaced by 15 new conflicts that have started in the past 5 years, the largest being the civil war in Syria. ISIS is driving out hundreds of thousands from Iraq, and insurgents are driving people out of North Africa as well. Ultimately, violence is driving these people from their homes, and the closest, wealthiest countries are in Europe, many of which have a history of welcoming refugees. Some countries are welcoming these people who have risked their lives in flight while others are building walls to keep refugees out or are blocking deals that would provide aid.

The influx of all of these peoples has become a real challenge for transportation providers, shelters, border crossings, and registration centers. There is no simple fix for this situation which will further tax the economic wellbeing of the Eurozone, but some solution must be found.

Waxing or Waning?

While there are both lunar cycles and market cycles, the moon’s cycle is much simpler to understand. Even most casual observers can tell you whether the moon is waxing vs waning. At this phase of the market cycle, we are proceeding with caution in all of our investment strategies as all major stock market benchmarks are now negative year-to-date.  Domestic equities have largely been range-bound with a recent negative trend.  European equity charts look similar, albeit with more volatility. Chinese equity charts look like a mountain with a clearly identifiable high in June.  In fact, most stock market benchmarks appear to have topped out in June and are now testing downside support levels.

You’ve probably heard or read before those markets really dislike uncertainty. Well, these are certainly uncertain times. Until market participants see some clarity in central bank policies, and until the global economic growth picture comes into better focus, we anticipate that investors will continue to experience heightened volatility in their accounts. Bond allocations may experience some volatility too, if and when interest rates begin to rise, but bonds should experience far less volatility than stocks. We continue to monitor economic fundamentals and market technicals.