Third Quarter 2015 Commentaries

It was a nasty quarter for stocks. It has been four years since investors last experienced such misery. For the quarter, S&P 500 were down 6.44%. From its peak on May 21, the index was down 9.22%. By the standard of history, it was a rather mild downturn. Yet, investors who have become accustomed to the subdued volatility of the post 2008 crisis economy, it was rather unnerving.

It started all so logically. The economy of China had been the growth engine of the world. For years it had grown in excess of 10%. Alas, just as trees don’t grow to the sky, double digit growth rate could not be indefinitely sustained. First it slowed to 9%, then 8%, now only the most credulous still believes the official promulgation of 7% growth rate. Suffice to say, growth engine China is no more. With such realization, the property market has softened and a stock market bubble is leaking in progress.

It is certainly reasonable to assume that the slowing of the Chinese economy will affect global growth. In turn, it will negatively affect US corporate profit. So in May, US stocks began a process of correction during the worst of Chinese stock market’s nosedive. By late August, the bottom had been found and market was stabilized.

Yet a new wave of selling has materialized since the Federal Reserve in difference to emerging market volatility decided to hold off on interest rate hike. Perhaps it was the indecision by the Fed; perhaps it was the suspicion that the world economy is really worse than we have thought. Stock market certainly was not comforted by the Fed’s seemingly friendly gesture. Sometimes market just defies explanation.

Unfortunately, there are no easy rules to predict when a 10% correction could turn into a 20% bear market. Neither indiscriminate selling nor doubling down leads to consistent investment success. The risk of substantial loss in the near term is the very reason for the long term higher return of equities. With such characters of equity investing in mind, we use asset allocation as our primary means for protection and our attention is firmly focused on the long term prospect of the companies we hold.

Despite the general pessimism, we are reasonably constructive on stocks at the current level. It should be pointed out that the US economic growth remains healthy. Labor market has been strong and consumer confidence is upbeat. As we enter earnings reporting season, expectation for third quarter earnings is very low. I believe there is a high possibility that such low expectation will be generally exceeded and setting up for favorable stock movements. Energy stocks are now discounting a prolonged period of low energy prices. US energy production has gradually slowed as we pass the anniversary of peak oil price and hedges gradually roll off. In fact, October would likely mark the beginning of daily oil production declines. Last, given the European state of economy and its heavier reliance in Chinese growth, the ECB may decide on a significant increase of its quantitative easing program.

Dong Hao Zhang
President & Chief Investment Officer Evla Hills Investment Management