Market insight: Have we entered a ‘corrective’ period?

Wade Balliet
Posted by Wade Balliet
Investment Strategy

I thought I would touch base given the unsettled equity markets in the past several weeks. At this point we are revisiting the pullback experienced in January, and, frankly in our view, a period of consolidation is long overdue but difficult to time. The equity markets were fully valued and/or slightly overvalued until the selloff that has occurred in the past couple of weeks.

Partial side view of stock market information display with bright, bustling city nightlife in the background.One could now argue the equity market now looks to be fairly valued and/or even oversold. The current time period, with third quarter corporate earnings, is a period rife with opportunity for news and emotion to move the market, of which there is a surplus of both.

We believe the economic conditions in the U.S. are improving, not declining. Additionally, it is our belief that a slowdown or recession in Europe will not concurrently sink the U.S. economy into a recession as our export of goods and services to Europe totals 17% of aggregate, according to the U.S. Census Bureau. The U.S. is on stronger footings as the economy improves to a growth rate above 2% for the foreseeable future. The Federal Reserve will take the current U.S. economic and global conditions into account as they make adjustments to their policy. In our opinion the Federal Reserve will be methodically slow on moving rates higher, given low inflation and slack in the economy.

There has been a growing chorus, primarily in the media, that the “bull market” has run its course; and concerns over growth in Europe, China, and a myriad of other ancillary world items, such as Ebola, have taken their toll. It is our case that:

1. We are going through a corrective period and not an end to positive equity performance.

2. Concerns over Europe are a bit overdone. The reality is that the Eurozone has been growing at 1% or less for the past several quarters, according to Eurostat, and a turn to negative GDP growth simply doesn’t impact the overall global economy to the same magnitude as if it had been growing at a 4% rate.

3. Similarly worries over China may simply have been exacerbated by the ongoing protests in Hong Kong. Chinese economic growth is slowing, but we don’t see a hard landing in the cards and expect China to continue to grow at a faster pace than the U.S. or other developed economies in the near term.

4. Consensus estimates of earnings growth for the 3rd quarter are in the 3-7% range over last year, and we’ve seen repeatedly that analysts tend to panic and cut estimates prior to reporting. There is every reason, given the continued improvement in the U.S. economy and historically high profitability metrics for many domestic corporations, we currently expect earnings to come in at or above expectations.

The talking heads like to describe the trajectory of equities since March of 2009 as straight up; the reality is that things have been considerably more uneven. In 2011, the S&P 500 Index posted a return of just 2%. Practically every other equity asset class posted negative returns that year. Additionally, sectors and asset classes in the equity market have experienced corrections of 10% or more in 2014 (example biotech, energy, and U.S. small cap stocks). Corrections are normal for a recovery cycle. Lastly, as previously stated, we believe the economic conditions in the U.S. are improving, not declining.

We will continue to monitor the markets closely. If you have any questions please let me know.

All investments involve risk.

The views presented are those of the Investment Management and Trust Division of the Bank of the West Wealth Management Group and should not be construed as investment advice or an expression of the Bank’s view as to whether a particular security or financial strategy is appropriate for you and meets your financial objectives. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Investors should seek the advice of a financial professional regarding the appropriateness of any securities or strategies discussed. Past performance is no guarantee of future results.

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