Stocks plunge, rebound to end week slightly higher

As in roulette, same is true of the stock trader, who will find that the expense of trading weights the dice heavily against him. – Benjamin Graham

The S&P 500 Index went on a roller coaster ride last week, plunging more than 12% from its 2015 highs on Tuesday only to finish the week in positive territory after huge gains on Wednesday and Thursday. In fact, the two-day gain was the largest ever recorded. The stock market closed about 1% higher for the week after exceeding the 10% threshold on the downside often defined as a correction. Continued concerns over slowing global economic growth, particularly in China, were largely responsible for the increased volatility and that volatility is likely to remain for the foreseeable future. Investors should remain cautious as risks are elevated despite the snapback in the stock market. The Federal Reserve is scheduled to meet on September 16^th and 17^th and the question of whether or not there will be an interest rate hike will finally be answered. Certainly the recent outsized market volatility, weaker economic growth in China and fragile economies worldwide could factor into the Fed’s decision and cause an increase in the fed funds rate to be postponed. The decision is made even more complicated after several pieces of U.S. economic data were released last week. Durable goods orders in July were stronger than expected and business investment posted its biggest gain since June 2014. Second quarter gross domestic product (GDP) was also revised higher from an annual rate of 2.3% to 3.7%, much faster growth than what had been forecast as business investment and consumer spending were both strong. Taken by itself, an argument could be made for a rate hike in September based on this data. On the other hand, the fed-futures market, which has a history of being fairly accurate, suggests that there will be no rate hike next month. Either way, fasten your seat belts as the stock market is likely to be in for a bumpy ride over the next few months.

Last Week

Housing data released last week was generally positive as the Case-Shiller home price index rose 1% in June and July new home sales and pending home sales also increased modestly. As mentioned above, U.S. durable goods in July were strong, up 2% while June orders were also revised higher to 4.1%. Excluding the often-volatile transportation sector, core business investment orders rose 2.2%, another encouraging sign for the economy.

In an effort to calm nervous investors in the Shanghai Composite Index, China’s central bank lowered the benchmark lending and deposit rates and pumped more liquidity into the economy. This stock index had dropped more than 20% during the week before recovering to end the week down 8%.

 For the week, the Dow Jones Industrial Average rose 1.1% to close at 16,643 while the S&P 500 Index added 0.9% to close at 1,988. The Nasdaq Composite Index gained 2.6% to close at 4,828. 

 This Week

The most significant piece of economic data will be released on Friday when the August employment report should show an increase of 220,000 new jobs and an unemployment rate of 5.2% compared to 5.3% for July. The Institute for Supply Management (ISM) manufacturing index for August should match the reading in July and automobile sales should remain strong despite dropping slightly. The ISM nonmanufacturing index should also register above-average services growth, although a tad weaker than last month. July construction spending and factory orders are expected to be modestly higher, too.

The earnings calendar will be light this week with Medtronic, H&R Block, Joy Global, Campbell Soup and Dollar Tree among the most familiar companies due to report.

Portfolio Strategy

It has been more than 1,300 days since the stock market has undergone as much as a 10% correction and history tells us that typically one happens every 260 days. The absence of volatility this year with the S&P 500 Index trading in a very narrow range lulled investors into a false sense of security. In a flat or rising stock market, it’s easy to believe in a buy and hold approach using proper asset allocation based on one’s investment objective and time horizon. But when volatility rears its ugly head as it did last week and stocks begin to slide for no apparent reason, it’s tempting to panic and pull out of the market. During times of market turbulence, it’s never wise to make portfolio decisions since these decisions are usually made based on fear and emotion. It’s far better to review the equity allocation of a portfolio and one’s investment goals during a period of relative market calm. Investors who cannot live either financially or emotionally with the recent gyrations in the stock market probably have too much invested in equities and should cut back. Market timing also is a strategy that should be avoided as investors not only have to be right on when to sell their stocks, they also have to be right on when to get back in. As evidenced last week and back in 2008-2009, too many people often sell their stocks after prices have already fallen considerably. Even if they manage to sell at the right time, they may miss the best opportunity to get back in and squander their advantage. They don’t ring a bell at the top and they don’t ring a bell at the bottom. Money that is invested in stocks should be held for the long-term, with a minimum of at least five years and a normal holding period of ten years or more. Over the long haul, stocks have outperformed all other asset classes, but returns have also fluctuated much more than other investments. It’s important to keep this risk-reward tradeoff in mind when determining the proper asset allocation of your portfolio.