Last week saw a significant decline in the market averages. For much of this year markets have been unusually calm, though that has certainly changed. I will try to examine whether the events of last week were just a short-term aberration, or were indicative of fundamental changes occurring. Readers should note that this column is being written on Monday morning, so new events will have occurred since then.
Developments in Europe are once again influencing global markets. In recent years there were concerns about the credit ratings of several European countries notably, Greece, Italy and Spain. As those concerns lessened global markets staged a strong recovery, especially in 2013.
This past week saw negative news coming from Germany with industrial production and exports dropping significantly. Germany is the largest economy in Europe, and until recently had been performing better than most of the other countries in that region.
A principal reason for the dramatic slowdown in Germany has been the sanctions against Russia. Germany is a major trading partner with Russia, so it is being impacted much more by the sanctions versus our country, where we do little business with Russia.
From the perspective of the U.S., the developments in Europe should not have a major impact on our economy. Sales to Europe total approximately 13 percent of our total exports, a large enough amount to notice, but certainly not enough to derail our economy. Over time Europe has played a diminishing role with respect to our economy versus Asia and Latin America.
In addition economic news in our country has been somewhat better compared to earlier in the year. The recent decline in gasoline prices should work like a tax cut for American consumers. In addition mortgage rates are back to near record lows, which is a positive for the housing industry.
Whenever the market sells off there is normally contradictory commentary saying either to buy the dip, or the market will keep sliding. Given that we have had two market declines of approximately 50 percent over the past 15 years there is certainly fear that we could be in for a more significant correction.
There were unusual developments that occurred that caused the prior market declines. During the 2000 to 2002 period the valuation of the market was exceedingly high, especially among tech companies, and also during that period we had the 9/11 terrorist bombing. The market decline during 2008 occurred during a severe recession caused by a major crisis in the banking system.
At the present time we do not have the characteristics in place that caused the prior market downturns. The current valuation of the market, while clearly not a bargain, is not close to the excesses that we saw in early 2000. Our banking system and economy is gradually improving at present, so there is nothing to indicate a looming recession on the horizon.
What is likely to occur near term is that volatility will remain somewhat elevated for a period of time. This would mean both strong up days and down days. Over time I would expect the market to gradually calm down.
Obviously a more significant market correction will eventually occur. While there is the possibility that we are in the early stages of one, the economic landscape does not indicate that a market correction would be very severe. Most likely this market downturn should not be much more significant versus what we experienced earlier this year.
Market declines are frequently a good test of someone’s risk tolerance. If a person is heavily invested in stocks, and is completely stressed out by the recent decline, then most likely that individual has too much in stocks. However, for a long-term investor whose stock holdings are in accordance with their risk tolerance, I do not believe changes are necessary at the present time.