Q3 2015 Commentary

The decline in the stock market reflected concerns about both real and imagined threats to the US economy and corporate profits. Among those threats was an anticipated 25 basis points increase in the Fed Funds rate. Market participants have been waiting for this modest rate increase for more than a year. Each time it appears the rate increase is imminent, the market has sold off, but the Fed has not acted. Moreover, when the Fed does nudge rates up, there is no historical evidence to support the conclusion the 25 basis point increase will have any significant impact on economic activity.

The conditions of both the Chinese economy and the Chinese stock market were thought to be another threat to economic growth in the US. The growth rate of the Chinese economy has slowed substantially. The abrupt slowdown has been seen by some as evidence that the Chinese economic model is not viable. Investors in the US are waiting to see if the Chinese Government can implement policies capable of reversing the declining rate of growth.

As the economic slowdown materialized, the Chinese stock market plunged. The magnitude of the impact of this stock market decline and the economic slowdown on the US economy is hard to discern. However, an abrupt decline in commodity prices is linked to the slowdown in China. This decline in prices is, in turn, helping to drive down the value of stocks with significant exposures to changes in commodity prices.

In addition to the threats and concerns described above, investors were discouraged by the devaluation of the Chinese currency, stagnating wages in the US, a falling workforce participation rate, and a host of other perceived threats to the US economy and corporate profits. These concerns to the contrary notwithstanding, the consensus forecast for economic growth in the US remains in the 2% to 3% range for the near future.

The market has declined and become more volatile in the last three quarters. We have seen episodes characterized by this type of market environment in the past and if the past is any guide, the market’s behavior will improve wen the outlook for increased real economic growth and rising corporate profits becomes clearer. The timing of the change in outlook is uncertain, and rather than trying to anticipate the timing, we continue to focus our efforts on the process of identifying stocks with reasonable valuations, and an above average likelihood of favorable changes in profits. It is our expectation stocks with these attributes will do well when the behavior of the stock market becomes more favorable.