Anyone that has experienced a long road trip with children has heard that question before, and we apologize for dredging up the memory. Investors were reminded of those anxious and impatient feelings over the past two weeks of trading. After all, it is difficult to remain unfazed by a market that drops over 11% in just six trading days, as the S&P did from August 18th through August 25th. And while there is no doubt that many investors will be happy to put August in the rear view mirror, the issues in China that caused the recent turmoil may not be resolved as quickly as we would like.
To recap: the S&P 500 briefly entered correction territory , defined as a 10% decline from a recent peak, before recovering to end higher for the week. The Dow Jones posted its largest ever one day intraday point loss on Monday (in absolute, but certainly not percentage terms) due to fears of slowing Chinese growth and its impact on the global economy. The selling was intensified by automatic selling by retail investors, leading to one of the most volatile trading days ever.
On Tuesday, U.S. markets opened sharply higher as China’s central bank responded aggressively with easier money, although the rally was reversed and the averages actually closed the day lower. To the relief of many, Wednesday brought good economic news as durable goods orders increased by the most since June 2014, and the market was able to sustain a nearly 4% rally, its single best day since 2011. At that point, we were ready for the weekend to begin!
Thursday brought a continued rally with news of a positive revision to second quarter GDP of 3.7%, beating expectations of a 3.2% gain. The roller coaster week finally ended with a flat day on Friday, as stocks stabilized on hopes that the domestic economic picture is strong enough to withstand China’s negative effects. While the China situation remains unsettled, and many market participants are now willing to entertain worst-case outcomes there, we repeat our comment from last week that the impact will be far more severe for the emerging world and not nearly as much of a big deal for the U.S. economy.
While analysts disagreed about the transitory nature of some of the factors that gave us the strong second quarter GDP revision, the outlook for the U.S. economy has been steadily improving. As we mentioned last week, the labor market, housing and spending are all showing momentum, though the outlook for export-oriented manufacturing activities remains weak. The major domestic uncertainty resides with the Fed’s first rate hike decision. A factor cited in last week’s rally off the lows was the increased probability that the Fed may hold off in September and delay rate hikes to a later date.
With or without the Fed, the market needs confidence in the corporate earnings picture, which has been subdued at best. Earnings growth in the second quarter earnings season, which is about to come to an end, was negative compared to the same quarter last year. Even adjusting for the drag from the energy sector and the effect of the strong U.S. dollar, earnings for the S&P 500 are up only in the mid-single digits, hardly enough to sustain a bullish uptrend. Markets are forward-looking and will depend on stronger earnings growth for the rest of 2015 and beyond for the rally to continue.