A Bear Market Made in China?
The current weakness in the U.S. equity markets is a correction within a longer term bull market, similar to what we experienced in 2011 and 1997. We do not believe it is the start of a major bear market as in 2000 and 2008, for a number of reasons.
The causes of the selloff come from abroad (namely China and emerging markets), and are not domestic in nature. Chinese stocks have sharply reversed after having been in a bubble or exponential rise for the past year. China’s economy, though continuing to slow, is still growing and is not as connected to its equity market as in many other countries. Additionally, China is not as big a trading partner with us as many believe. It constitutes 7% of U.S. exports and is less than 1% of total U.S. GDP. As a result, the Chinese economy has only a 16% correlation to ours, though individual areas, such as commercial aircraft, automobiles and commodity related industries are impacted more than others.
As mentioned in our past quarterly commentaries, the chief causes for major market declines in the U.S. have been recessions. Though many foreign economies have been weak over the last several years, our domestic economic growth has averaged between 2.00-2.50%. Additionally, the slope of the U.S. Treasury yield curve has been an excellent predictor of recessions over the past century, with positively sloped curves as we have today indicating continued economic expansion. In contrast, negatively sloped curves where the 90 day Treasury bill yield exceeds the 30 year Treasury bond yield indicate tight credit and an impending downturn in the economy. As some investors fret over the timing of the Fed’s first rate increase, keep in mind that bull markets end after the last of a series of rate increases, not the first one. Finally, the economic excesses that presaged earlier recessions are not present now.
To put the current stock market correction into perspective, during the last secular bull market which lasted from 1982 to 2000, there were several corrections of at least 10%. Equities achieved new highs within a year after the correction was complete in all but one instance, — the Crash of 1987, in which stocks took two years to fully recover. We recommend staying the course and as mentioned repeatedly over the past two years, we continue to emphasize developed markets such as the U.S., Japan and Europe versus emerging ones and maintaining an underweighting in commodities.