Slipping China, U.S. Indecision Point to Market Correction

August
24

Written by: Jon McGraw

yuanCorrection!

According to Barron’s, the Dow Jones Industrial Average lost about 6 percent last week, placing the benchmark index around 10 percent below its record high on May 19.

A drop of that magnitude from a new high may be a market correction, a brief, jarring plunge in value that often forces investors to reassess the state of the market and the health of the companies they hold. If investors judge markets and holdings to be sound, a correction becomes a buying opportunity. Nothing is certain—there is still a chance the markets could fall further—but a drop of 20 percent or more is considered a bear market.

The Standard & Poor’s 500 Index lost about the same amount as the Dow last week, and is down almost 8 percent from its May high. While it’s not technically in correction territory, a dip that’s greater than 5 percent and less than 10 is definitely a pullback.

Many factors contributed to the unsteady United States stock market performance last week, and concerns about global recovery were top of mind for many investors. China’s slowdown may significantly reduce demand for commodities, and emerging markets dependent on commodity exports are struggling. CNN Money reported:

“China’s economic slowdown and currency devaluation have investors worried that things could get worse as the year goes on. Developing countries like Brazil and Russia are struggling to revive their economies as their currencies depreciate dramatically against the dollar. Brazil’s currency value has declined over 20 percent and Russia’s over 40 percent, hurting imports and everyday citizens. It’s also a huge worry for America’s biggest companies. About 44 percent of the revenues from S&P 500 companies come from outside the United States.”

Currency depreciation is market-driven. It sometimes causes investors to pull assets out of a country, which puts more pressure on the currency. Currency devaluation, where the government makes a deliberate downward adjustment in currency value, is something different entirely.

Uncertainty about the timing of a rate hike in America certainly didn’t help matters. Right after the minutes of the July Federal Open Market Committee meeting were released last week, CNBC reported that “almost all members” had some concerns about the strength of U.S. economic growth. Meanwhile, the CME FedWatch barometer put the likelihood of a September increase at just 24 percent—a 45 percent drop from the previous day.

Data as of 8/21/15 1-Week Y-T-D 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks) -5.8% -4.3% -1.1% 11.7% 13.1% 4.9%
Dow Jones Global ex-U.S. -5.0 -4.9 -13.1 2.8 2.5 1.7
10-year Treasury Note (Yield Only) 2.1 NA 2.4 1.8 2.6 4.2
Gold (per ounce) 3.4 -3.6 -9.3 -11.0 -1.2 10.2
Bloomberg Commodity Index -2.8 -15.8 -30.0 -15.6 -7.7 -6.1
DJ Equity All REIT Total Return Index -2.4 -1.8 4.3 9.8 13.7 7.3

From Abstract to Reality: The Potential Effects of Rising Rates

When economic data align and the Federal Reserve pulls the trigger on tighter monetary policy, rising interest rates may affect everything from mortgage rates to bond yields to economic growth. Here are a few of the possible consequences:

  • Higher demand for short-term bonds. When interest rates rise, bond values fall, and vice versa. However, changes in bond values will be influenced by the speed and magnitude of the rate change. A sharp increase over a short period would have a greater effect than a gradual rise over a longer period. To date, the Fed has indicated the fed funds rate will rise gradually. Experts cited by The Wall Street Journal suggest that shorter-term bonds and cash will be more attractive than longer-term bonds for a period of time.
  • Less attractive loan terms and credit card incentives. By raising the fed funds rate, the Fed will increase borrowing costs. That’s likely to affect mortgage rates as well as automobile and other consumer loan rates. The Journal encouraged homebuyers to be wary of adjustable-rate mortgages and indicated that zero percent introductory offers on credit cards may disappear.
  • Slow improvement in savings account returns. Over the longer term, rising rates may be a boon for savers, but there is likely to be little immediate change in the yields offered on savings accounts. That’s because banks set these rates. In general, banks raise rates to attract deposits, and few banks need to do that right now, according to an expert cited by The Wall Street Journal.

While it seems counterintuitive, tightening monetary policy will not affect interest rates equally across all markets.

Weekly Fun—Think About It

“The individual investor should act consistently as an investor and not as a speculator.”

Benjamin Graham, American economist