Posted: January 07, 2016
Stocks have opened the year in the red. In fact, the first three trading days have produced the sixth-worst performance for that period of time since 1929. However, we want to encourage our clients not to panic. Despite the fact that volatility such as this is normal in the later stages of an economic cycle and bull market, and we are now in the seventh year for both, we do not foresee a U.S. recession in 2016, nor do we believe this downturn portends another financial crisis like that of 2008.
What’s causing the decline?
Investors entered 2016 with very little conviction about the stock market. 2015 ended on a weak note, and most were in agreement that the global economy is slowing as we near the end of the economic cycle, while the potential for stock gains is limited. The pessimism was further supported when the Chinese government allowed its currency to depreciate, which caused losses in Chinese stocks, as many saw the currency move as a sign of greater economic weakness in China than what’s been disclosed. These pressures have been further exacerbated by another leg down in oil prices, as inventory data continues to demonstrate excess supply, and concerns grow about global demand. Finally, fresh geopolitical concerns have appeared as a result of actions in Iran and North Korea.
Why do we not see another 2008 crisis?
In 2008, the problem began with a housing bubble in the U.S. that led to a severe economic contraction and credit market collapse. Today, in contrast, the U.S. economy is on solid footing. Although growth in 2016 will likely only be in the 2 percent range, the combination of a strong consumer (consumer confidence was reported today at a multiyear high), low interest rates and oil prices, and new government spending will be sufficient to prevent a recession this year. Please be aware that recessions have historically been caused by rising oil prices and a significant jump in rates, which we have clearly not seen at this point. High yield bond spreads have been flashing a warning sign for several months, but we don’t think they are projecting a recession in the near term.
Also, note that U.S. banks have 2.5 times as much high-quality capital as they had prior to the Financial Crisis, while the problem debts (e.g., Emerging Market debt) are much more widely disbursed today among non-bank creditors. So the potential for a systemic financial crisis is very low. In addition, it’s important to realize that the current sell-off is not a reaction to the recent Fed Funds rate hike, nor do we see any of the current geopolitical issues, which have persisted for many years, to be an issue of real near-term concern.
Our 2016 Outlook
As we’ve been consistent in saying, we believe economic growth will be lower than historical norms this year, likely in the 2 percent range, while investment returns will be modest. Based on our analysis, the U.S. stock market has the potential to return low- to mid-single digits this year, but in a volatile fashion. We don’t see a recession on the horizon, so we don’t believe a bear market is likely near term.
It’s important to note that we have experienced a stock market decline of 2.5 percent or more in the first three trading days on six occasions since 1929, and the market still produced a positive first quarter return in 50 percent of those occasions. So, a poor start to the year does not necessarily doom us to a negative first quarter or full year.
As always, we recommend that our investors remain calm and resist the urge to overreact in situations such as this. Recall the correction in August, when the market fell 12 percent based on similar concerns about China and oil prices? Stocks recovered nearly all of that loss by the end of October, so those who sold in August locked in losses that would have been more or less erased within the next two months.
Thank you for your confidence in GuideStone. We are committed to earning your trust every day and will continue to communicate with you as developments occur.
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