As expected, last week we saw tremendous volatility in the markets. The Dow Jones Industrial Average was down over 1,000 points at market open on Monday and had recovered significantly during the remainder of the week. Commodity prices, namely oil, rose from its lows on Monday of just below $38/barrel. The market intervention by China to support its equity market after the significant declines has reassured market participants across the globe, for now, that China may avert a "hard landing." So where do we go from here in the markets and the economy?
We began this year with the investment thesis that 2015 will be the year that "Main Street outperforms Wall Street." This theme seems to be playing out, as financial assets have seen decreasing values and increasing volatility while the U.S. economy continues to be steady. The last few weeks have seen some of the best economic data of the entire year, but it has been overshadowed by the concerns about China and the volatility in the stock market. Last week's economic data, namely August Consumer Confidence, Durable Goods and the revision to second quarter Gross Domestic Product were all stronger than the prior period as well as the market expectation.
This causes a conundrum for the Federal Reserve (Fed). Should they react to the volatility in the market and hold off increasing interest rates? Or, should they follow the economic data and raise rates? I think the Fed will follow the economic data and continue to move forward with tightening monetary policy in September. It is not a slam dunk on which way the Fed will decide, but I think a strong employment number on Friday will cast the deciding vote. This chain of events most likely leads to further declines for stocks in the short term. If the Fed decides to hold off on tightening and states they want to see inflation expectations increase (they are still very low), I would be a buyer of equities because you would have global central banks coordinated in easy monetary policy.
We shortened the portfolio duration when the 10-year yield fell below 2%, and that trade has been favorable to date. With hindsight, the recent events in China may have more of a negative impact on bonds than stocks, as the Chinese Central Bank may need to sell U.S. Treasury bonds due to capital outflows and the devaluation of the Yuan. Remaining short duration in the U.S. bond market is our preferred position for now.
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