For the past several weeks, the markets have been more volatile than usual. August saw the S&P 500 Total Return Index falling 6.26%, the largest calendar month decline since May 2012. This volatility was sparked primarily by concerns about China’s economy, and when the Federal Reserve might raise the Federal Funds rate.
With regards to China, it is very hard to gauge what is happening and how their transition from an export-led to consumer-led economy will unfold. As investors, the best we can do is to diversify our risk and exposure to China, so that any impacts are minimal.
Here in the U.S., we are a little more concerned with the Fed. We’ve had over six years of “easy money” policy that has caused both the stock market and bond market to go up significantly. When Ben Bernanke instituted quantitative easing, it was with the goal of reducing unemployment. Mission accomplished – we’ve gone from a peak of 10.0% unemployment to 5.1% unemployment.
Towards the end of Bernanke’s term, the focus, while still heavily on the labor market, took a slight shift to also include inflation. Since the Great Recession, inflation has been below the Fed’s 2% target. This has apparently created a dilemma for the Fed with regards to raising rates. Reading between the lines of the last couple of press releases, it appears the Fed has adopted a third mandate: stability of global markets.
As U.S. economic data has continued to come in strong in 2015, many market observers expected a slight rate increase at the Fed’s September meeting. Instead, the Fed disappointed many by keeping the status quo.
Chairwoman Yellen cited several reasons:
- Lower net exports and impact on GDP growth (think Europe and strong dollar)
- China and financial market instability
- Labor market slack
- Lower than desired inflation
While I could entertain you with my opinions on these points, and why monetary policy is not the solution, I will move on to what this means for investments. If nothing else, the Fed has made the future more uncertain. Chairwoman Yellen has said that they may raise rates in October. But there will be minimal additional data available between now and October, making it unlikely. As a result, we’ll see volatility continue until there is a resolution and the Fed pulls the trigger.
While we all aspire to be great short-term traders, the more important view to keep in mind is that investing is a long-term game. As a financial advisor, we’ve been preparing our clients for an eventual rate increase and temporary volatility. However, we’ve also been reviewing long-term asset allocation strategies and ways to diversify risks we see looming over the next several years.