Once again the markets are seeing a surge in volatility, this time centered on further declines in commodity prices and growing risks among high-yield securities. Additionally, everyone is watching the Fed as they are poised to implement the first rate increase since June 2006 and at least partially unsure as to what that will mean for the markets.
Regardless of the interest rate decision, we believe the former developments are part of a growing mosaic that indicate growth in the U.S. economy is decelerating and could face still more headwinds in 2016. What are some of the other factors that we have observed supporting this thesis?
- Poor market breadth, meaning that while the broad market averages have held up O.K., a larger number of individual stocks are falling behind. The performance of the large indices is increasing being driven by a handful of large stocks like such as Facebook, Amazon, Netflix, Google, Home Depot and Nike.
- Sectors sensitive to economic activity have increasingly come under pressure. In addition to the weakness in commodities, industry groups such as transportation and utilities sectors have also seen a tougher times.
- Weakness in leading indicators of business activity. The employment improvement has been impressive, but this change is a lagging indicator of future activity while those such as business survey data and measure like the inventory to sales ratio suggest slowdown.
- Price declines in high-yield mean risk premiums are expanding and this typically tempers the outlook and valuations for other assets, like stocks. While most of the weakness has been centered on the energy sector, the weakness in high-yield has recently expanded somewhat to other groups. Even for companies outside of these sectors, this can have an impact. The bull market has been aided in part by activity like stock repurchases and mergers and acquisitions that have been predicated in many cases on the issuance of more debt. Expanding risk premiums spreading through fixed income markets can make some of these deals less attractive.
How significant are the risks? We have taken incremental steps through the course of this year to reduce risk and economic sensitivity in many or our actively managed portfolios and that trend is likely to continue based on our research.
While we do not see risk factors reaching the severity levels which we say in 2008, we are mindful of their growing breadth. We also recognize the historic amount of stimulus initiated since that episode will continue to have a significant impact on market and their respective values.
In sum, the latest developments have prompted us to continue our earlier directions, but again in an incremental fashion. Should the market rally based on the Federal Reserve action our overall sentiments regarding the potential elevated levels of risk would remain unchanged.
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This commentary is intended for the dissemination of general information regarding market conditions to Lowe Wealth Advisors clients. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed in this report will come to pass. While any general market information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice.