“I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant.”
— Alan Greenspan
In the third quarter, global financial assets endured their worst decline in four years. There were few safe havens, as commodities, stocks, and most currencies and bonds participated in the descent. As mentioned in our special report from September, the catalyst was China and the consequences spread to other emerging markets.
Though it is clear growth in China has slowed, concerns of a recession there are overblown. While most likely not growing at a 7% clip, China’s economy is still growing, led by an expanding service sector which is offsetting much of the softness in the manufacturing sector. This is also apparent in the China sales figures of multinationals, with consumer companies such as Nike seeing rapid growth while manufacturers such as Caterpillar reporting poor revenue results. What may have discomforted observers more, however, was a series of policy missteps by Beijing, including aiding the creation of a stock market bubble, backtracking on economic reforms and a surprise devaluation of the yuan. Even Federal Reserve Chair Janet Yellen sounded some doubt about China when she remarked about the “deftness in which [China’s] policy makers were addressing those [economic] concerns.”
The Fed itself was not without fault, as investors grew frustrated over its equivocation on the timing of the first interest rate increase since 2006. After signaling at the beginning of summer a September increase, Fed officials voted to leave rates unchanged, citing global weakness as a major factor and causing some economists to cynically remark that the Fed now has a triple mandate, i.e. to control employment, inflation and the global markets. However, the markets subsequently have begun to regain confidence with the Fed, as Yellen’s caution is proving correct with the latest two employment reports showing moderation in job growth. Meanwhile, problems at firms such as Glencore, the commodities conglomerate, or Petrobras, the Brazilian controlled oil company, remain but have receded in recent days.
Keys to a turnaround in the markets include signs of stabilization in Chinese manufacturing and in commodities, particularly oil. Though fumbling with its policy responses lately, China is a “command economy,” with its government more able to directly influence its economic performance and steady the situation than in developed countries. U. S. petroleum production has been falling since April and recent Middle East unrest, especially with Russian intervention in Syria, may finally indicate a bottom for oil prices.
U. S. economic gains will be affected somewhat by these events, with an inventory drawdown also contributing to moderate expansion. Current estimates for third quarter GDP growth are settling in the 1.5-2% range, with manufacturing and exports feeling the brunt of the slowdown. The job market is still improving, though at a more tempered pace. Also, markedly lower gasoline prices are helping consumer spending, which equates to approximately 70% of our economy. A pickup in housing is also helping mitigate the effect of foreign economic weakness.
The Hawaii economy continues to expand and now has the third lowest unemployment rate in the country. Conditions may moderate here as well due to the stronger U. S. dollar impacting tourism and trade. Fortunately, the islands have so far avoided any major storms from the strong El Nino weather phenomenon that has occurred this year and which could directly and adversely affect us.
We are constructive on the outlook for U. S. equities, as the recent correction has removed pockets of speculation, especially among the smaller biotechs. The overall valuation of the market is reasonable. Concerns about profit growth are overstated, as the Fed’s report for corporate income is actually improving, with lower oil prices impacting the energy sector and masking improvement elsewhere. Domestically oriented consumer stocks should show good profit gains. Bond yields are likely to trade in a tight range, with the prospects for a 2015 rate hike by the Fed receding with each soft economic report. Developed, rather than emerging countries remain our choice among foreign markets.