Market Watch - October 2015

Submitted by Academy Wealth Advisers on September 30th, 2015

By Rick Welch October 1, 2015

We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our near term outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.

Status of our Investment Class Weightings

Changes from our July 2015 Market Watch are noted in italic.

US Large Cap Sectors –

Overweight – Financials, Healthcare, and Technology

Neutral – Consumer Discretionary, Consumer Staples, Industrials

Underweight – Energy (↓), Materials (↓)

No Weighting - Utilities

US Mid and Small Cap – Maintain all weightings.

International Developed Markets – Maintain all weightings.

Emerging Markets – Maintain all weightings.

Alternative Strategies – Maintain all weightings.

Multi-sector Bond Funds – Maintain all weightings.

Investment Grade US Corporate Bonds – Maintain all weightings.

High Yield US Corporate Bonds – Reduce positions.

Investment Grade Municipal Bonds – Maintain all weightings.

Data – Q3 was a difficult one for investors as the equity markets corrected for the first time since the summer of 2011. In August, the S&P 500 fell -6.25% which disappointing performance was followed by an additional loss of -2.64% in September. For 2015, we see the following YTD results: US Large Cap - S&P 500 (-6.74%), US Small Cap - Russell 2000 (-8.63%) and International - ACWX (-10.16%). Much of the domestic economic data for Q3 was mixed, in contrast to the volatile and slumping financial markets. GDP for Q2 came in at a strong +3.9%, which followed a growth rate of +0.7% (revised upward from an initially reported contraction) in Q1. During Q3, the yield on the benchmark 10-year US Treasury fell from 2.33% to 2.06%. Job growth over the last four months has averaged a strong 225,000 and the national unemployment rate has fallen to 5.1%, at or near the pre-recovery target of the Federal Reserve. New weekly unemployment claims averaged 273,000 during Q3 (slightly better than the 274,000 in Q2) suggesting a continued firming of the domestic job picture. Our earlier concerns about weak price inflation remain after a decrease of -0.1% in the CPI in August and the most recent 12-month reading of +0.2% which remains below the Fed target of 2.0%. Consumer confidence, as measured by both the Conference Board and the University of Michigan Consumer Sentiment Survey, fell in August as the market corrected, however, confidence remains at elevated levels as we head into the all-important holiday season of Q4. Retail sales increased in both July and August as the American consumer continues to enjoy prolonged savings at the gas pump. The September Business Outlook Survey by the Federal Reserve Bank of Philadelphia showed a decline to a multi-year low for current business conditions, while optimism for future conditions (6 months in the future) in the manufacturing sector remains good. Data from the housing sector has been volatile, however, the picture suggested is still one of improving conditions. New home sales were strong in both July (+12.0%) and August (+5.7%).

Outlook – Q3 provided a harsh reminder that markets can become volatile quickly and that as selling pressure builds a minor sell off can soon become a market correction. The fact that the correction of 2015 occurred during August and September is no surprise as these two last months of summer, from a statistical standpoint, are the worst months of the calendar year for financial markets. Trading was heavy, volatility spiked and market psychology turned gloomy after seven months of relative calm and range bound trading. As we move into Q4, we see slightly improving conditions with increased market volatility, especially in the weeks immediately before the next two FOMC meetings on Oct 27-28 and Dec 15-16.

Has the bull market run its course? We do not think so. The financial crisis of 2008-09 was historically broad and severe. Post-crisis recovery has been more gradual and muted which suggests that the recovery itself may take longer than expected. The US may actually be more in the middle of the recovery cycle than in the last stages of one. Remember bull markets do not end because they are too old, rather they end when the economy stops expanding and the next recession takes hold. That is not where we see the US economy as we end 2015 and move into 2016. We do not see the overall fundamentals of the US economy having changed and suggest that economic growth prospects still look relatively positive.

The weakest part of the US economy is foreign demand for our goods and services. Year-to-date exports project that 2015 may be the first post-crisis year in which the value of US exports has declined. This weakness is rooted in slower economic growth abroad and a strong US dollar. Many analysts believe that the rise in the dollar over the past year could serve to restrain economic growth through 2016 and perhaps into 2017. An initial short term rate hike by the Fed in Q4 could provide new fuel to push the dollar’s value even higher.

The Fed will continue to draw much scrutiny from investors in Q4. We think that a small rate hike would be welcome by the markets and be a signal from the Fed that the US economy is on solid footing. We see a 50/50 likelihood of the initial rate hike in Q4. We think that when it comes to predicting how the next rate hike cycle will play out, that the focus should be less on the timing of lift off and more on the magnitude and speed of the change. Opponents of a Q4 hike suggest falling commodity prices and global currency devaluations may continue to keep the rate of inflation here in the US not only in check, but far below the Fed targeted rate of 2.0%.

What about China? Over the past decade, China has been an engine of growth for the global economy. Recent concerns of weakening economic growth, and more particularly that growth has slowed more sharply than expected, contributed to the market turmoil we faced this summer. China’s slowing growth and surprise currency devaluation should not have a major impact on the US economy as China is not a major purchaser of US exported goods and services. In contrast, China’s major trading partners (especially those in emerging markets) could feel some short term negative impact. Concerns of global growth (including China) may serve to further the resolve of global central banks to continue extraordinarily easy monetary policies, which policies typically support the more cyclical market sectors, while also improving the potential for broader economic growth.