The third quarter of this year was an unpleasant one for investors. The stock market had its worst quarter’s performance in four years. The bond market was very volatile during the quarter as speculation regarding the Federal Reserve’s intentions ran wild. Bonds ended the quarter with small gains. The Fed’s decision to keep rates unchanged caused renewed fears that worldwide economic growth is slowing.
Much of the fear currently hurting the stock market comes from overseas. Economic weakness in China is causing concerns about the health of the global economy. Slow growth in the Eurozone and fears that there will be a widening to the conflict in the Middle East are also causing anxiety among investors. We also can’t forget the problems in Greece, which have not been fixed and will continue to boil to the surface from time to time. For the first time, the Fed announced that international economic conditions will be considered when making policy decisions. The world definitely continues to become a smaller place.
Economic growth in the U.S., while being adjusted lower, continues to be positive. While our growth rate has been frustratingly slow the past few years, there are several important positive factors that make a recession unlikely at this time. Dropping energy prices puts more money in consumer’s pockets and keeps inflation low. Likewise, both consumers and businesses continue to improve their balance sheets as they reduce debt levels. Consumer spending continues to be strong as do home prices. Also, household net worth is at an all-time high.
Since stocks have now experienced their first correction (10% drop) since 2011, we look at the question of where we go from here. On the negative front, world economies are likely to hurt U.S. economic growth, possible higher interest rates can undermine corporate earnings, and continued tightening of our labor markets puts upward pressure on wages. On the positive front, market valuations are not especially high, consumers continue to grow their purchasing power, and, overall, financial conditions remain supportive of growth. We believe a sell off to bear market territory is unlikely.
As long as we have such conflicting economic and market data, we will continue to see higher than normal volatility. We would expect stocks to end this year with a loss and bonds with slight gains. Conditions like we are in now are difficult for investors. We do feel, however, that any surprises are more likely to be on the upside than the downside. Markets can turn quickly and usually when people least expect it to happen.