The Dog Days Of Summer

The second quarter left most investors disappointed. After the upturn in stocks at the end of August, many investors hoped that the markets were going to make a swift recovery. Instead, investors experienced another month of volatility. While the US continues to do as well or better than the rest of the world, there are some political issues that concern investors and could shake up the US markets.

The world watched the US Federal Reserve closely in early September. Every new scrap of economic data was weighed based on its potential impact on the Fed’s impending decision about interest rates. Analyst expectations were almost evenly split between those that expected a rate hike and those that expected the Fed to hold steady. In the end, the Fed took the more cautious road and did not raise rates. The stock markets did not seem to like that decision, but it did not come as a surprise. Most analysts still expect a rate hike before the end of the year.

Just before the October 1st deadline, the US Congress passed a continuing resolution that allows the federal government to stay operational for two months, while legislators attempt to work out a longer-term budget that would get them through the 2016 presidential election. In the coming months, they need to pass a budget, raise the debt ceiling, and tackle several other contentious issues. Shutdowns inevitably rattle global markets and a default on US debt would have terrible and long-lasting effects on the US economy, so investors and analysts are hoping that Congress and the President work quickly to find resolutions.

Concerns about the Chinese economy continue to weigh on the global economy. Most of the data coming out of Beijing indicates that China’s economy is slowing down and that there are still some structural issues to address in its credit markets. While most analysts have a healthy distrust for the official gross domestic product (GDP) data released by the People’s Bank of China (PBoC), they will be paying careful attention to the next GDP data release on October 19 to gauge the Chinese government’s willingness to confront these inconsistencies. In the meantime, investors are reducing their exposure to China and its trading partners.

Over the past month, investors pulled nearly $15 billion out of emerging markets. Some of this may be attributed to concerns about disappointing growth prospects for markets that are so dependent on China, but the majority of it is due to concerns that interest rates will start to rise by the end of the year. During these years of low interest rates and “easy money” for borrowers, many emerging markets used debt to finance their growth. So long as interest rates stayed low, debt service was manageable and investors stayed optimistic. With interest rates likely to rise by the end of the year, investors need to reassess their emerging markets investments and focus on fundamentals to justify the added risk of venturing outside of developed markets.

In addition, Japan appears to be in recession. The technical definition of a recession is two or more consecutive quarters of negative growth. Japan’s economy contracted 1.2% in the second quarter and preliminary data indicates that it contracted about 1% during the third quarter. Economic struggles are not new to Japan—its aging population, struggling industrial sector, and declining consumer spending make any gains hard fought—but, as one of its largest trading partners, China’s troubles put pressure on Japan.

Oil prices continue to linger below $50 per barrel, which leaves prices down nearly 25% in the past three months. After an attempted recovery at the end of August, oil trended downward in September. This trend was supported by the passing of the nuclear agreement with Iran and with an unexpected increase in US oil production. At this point, the market is still oversupplied with oil and, unless the political situation in the Middle East heats up, oil prices will stay soft until that supply issue resolves