Flash Crash 2.0?
It has been a wild ride this morning. Once again, China, prospective Fed tightening, oil prices and fear bordering on panic are depressing markets today. The major averages were down well over 6% a few minutes into the open, driven primarily by algorithm-driven program trades with a “sell at any cost” mentality. In a sense, the machines took over for awhile, and the results were not pretty. The rally off of the bottom has been nothing short of stunning, but the day is not over yet.
After the trauma of 2008 and 2009, investors have enjoyed strong upward movement in the U.S. stock market, with the only major interruption being the relatively rapid 20% correction caused by the Japanese earthquake and China concerns in 2011. This past week has seen markets break down from trading ranges to the downside. Whether we enjoy it or not, money leaves the market faster than it comes in, and the emotions of downturns are painful. Complicating matters is that equity markets do not have a track record of correctly forecasting oncoming recessions. The fact is they trigger false alarms as often as they get it right.
Unfortunately, rapid and sometimes violent pullbacks represent normal behavior for capital markets. At Madison Park Capital Advisors, our job on days like this is to discern the difference between what the program trades are saying from what the economy and our indicators are saying. Where they differ, we lean into our indicators, and adjust our tactical portfolio allocations only when our indicators dictate that we do so.
Last week, U.S. economic news continued the recent theme of mixed messages and middling growth. Housing starts exceeded expectations, while the U.S. manufacturing purchasing index for August fell to its lowest reading since October 2013. Initial jobless claims were higher than expected, yet homebuilder confidence was positive. In general, domestic employment, housing, and services can still be described as trending positively.
One more note on China seems warranted. China accounts for only 7% of American exports, which represents less than 1% of U.S. gross domestic product. We understand that China represents macro risk, which indirectly affects equity markets here at home. That said, we continue to maintain a tactical overweight to less export-dependent areas of the U.S. economy, with an eye on our indicators to determine if prudent risk mitigation dictates a retreat to the sidelines and dry powder for better opportunities later. We are not there yet.