The Breezes Of August
The stock market made a strong recovery after sagging for almost two weeks, than plunged again on news that China had devalued its currency. Market followers usually overreact to news and the surprise 1.9% devaluation of the Yuan interrupted a strong rally in the U.S. stock market.
China, always a murky subject, presents a particularly uneven picture recently. Its government attempts to control its economy, as well as almost everything else, and the popping of its stock market bubble earlier this summer brought on a variety of government interventions. Previously lightly regulated and overly enthusiastic buyers inflated stock prices to levels that suddenly plunged forty percent during July on waves of margin calls which, as usual, precipitated forced selling.
In characteristic fashion, regulators banned short selling under threats of arrest, induced large mutual and pension funds to buy stock, loaned government funds to brokers and banned company insiders from selling stocks for six months. These measures stabilized the Chinese stock market without public reports of anyone being shot.
Its currency devaluation was intended to boost exports. The U.S. dollar continues its strength against other currencies, nice for tourists but a real drag on our exports. Its rise over the past year has taken an estimated 0.6% off overall economic growth, which made a modest recovery to a 2.3% pace in the June quarter. Slipping oil prices held back quarterly corporate earnings while lower retail pump prices propelled consumer spending to a 2.9% pace.
The Chinese devaluation may have tempered the Federal Reserve’s possible rate increase at its mid-September meeting. Although many sectors are showing strength, wage growth is still pitifully low. The Fed announced its decision will be data driven and an increase would not signal additional rounds of increases until the economy can show more sustained and broader strength.
The stock market has wobbled all year under the pressure of various uncertainties, among them the fiscal crisis in Greece. It has a substantial payment due next week that may put it back in our financial news.
Once again, the stock market has slid back to the levels at which it began the year. It provided double-digit returns for four of the past five years, pausing for breath only in 2011, which was flat. Halfway through the third quarter, modest improvement in the economy and corporate earnings should carry it to at least single-digit returns for 2015. Developing momentum could lead to another banner year in 2016 but prevailing uncertainties suggest that our strategy of emphasizing well-capitalized companies with superior growth prospects will prevail.
Most investors are reactive followers of past events, allowing headlines to prompt sudden decisions. The harder trick is to observe and anticipate developing trends. The financial crisis sprang from the sudden exposure of trillions of dollars of very bad loans, yet there were no headlines during their development like “Fifty billions dubious sub-prime loans made today.”
While the extent and timing of higher interest rates are unclear, I have little doubt that interest rates are headed higher and bond prices are going down. That demands easing out of bonds and highly leveraged companies. Oil prices have not bottomed and energy stocks are unlikely to rebound soon.
Tech stocks are doing well although some subsectors like semiconductors have rough spots. The medical group, buoyed by funds from the Affordable Care Act, remains favorably placed. AbbVie (ABBV-$68), a new buy, is the former pharmaceutical arm of Abbot Labs. It is approaching $22 billion in sales with both sales and earnings growing at rates of 17% to more than 20%. Its P/E on 2015 estimated earnings of $4.25 (up 28%) is 16, less than that of the S&P.
August is showing its usual irregularities. I still expect the fall bring us a successful close to the year. Enjoy the summer.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622