On August 10th the S&P 500 was at 2104. By August 25th it was at 1868. In other words, the S&P had fallen by 236 points, or 11.22% in 11 trading days. What caused this and what does it mean?

The presumed cause of market declines worldwide is that China faced up to the fact that their economy was not growing as fast as needed or as had been reported by their previous statistical data. In an analysis I did in late March, I had determined that the Chinese economy was likely growing at between 4% & 4.5%. This was subsequently confirmed by two large economic firms that showed growth of 3.75% to 4.5%. This is well under the Chinese target of 7%. For this reason, we do not have Chinese stock positions or emerging market positions in our managed portfolios. As the Chinese stock market saw a collapse of confidence in their stock market, beginning in June, this fell over to a devaluation of their currency and a major exit of funds from China to other places in the world. The reaction in China lead to a panic in Asia that then spilled out to the rest of the world, including the U.S. This disruption to the U.S. stock market gives us a clear indication of how closely world markets work. The fact is that exports to China are just a hundred and sixty-five billion dollars, less than 1% of GDP. This means the near term impact on the U.S. is small. Goldman Sachs estimates that a 1% drop in China’s growth rate translates into a mere 0.06% drop in the U.S. GDP. Also, Goldman indicates that just 2% of the S&P’s revenues come from China sales.

This “correction” is to be expected. Corporations have been hiring large numbers of employees each month since August 2014. Many of these employees are still undergoing training and are not yet very productive. This impacts corporations with higher expenses, salaries of new employees and benefits, and lack of major earning from the hires, until they are fully trained. This should, and has, lowered earnings expectations. These new employees, once trained and confident in their jobs, will be spending money as consumers and their productivity will go up. Long-term, this is good for the economy. Also, we do not have much slack in unemployment. The continued demand for new hires is likely to result in increases in wages and salaries. This too is good for consumer spending. Because consumer spending is the major contributor to the U.S. economy, all of this bodes well for the future.

It is my belief that the U.S. will benefit from all of the above by the last quarter of this year and into 2016 and 2017. In the meantime, I am very glad that we are well diversified. Although our accounts went down with the market in August, our clients did far better at mitigating losses because we were so diversified.

Ed Mallon
September 8, 2015