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Altium's View of Recent Market Volatility

On behalf of the Altium Investment Committee;

What should we make of the most recent market volatility?

Over the past several weeks the markets have become increasingly more volatile. We believe that the weakness is the result of a combination of factors; concerns over weakening economic growth in China (the world’s second largest economy) and its surprise devaluation of its currency, plunging commodity prices and the ambiguity surrounding the Federal Reserve raising short term interest rates. 

Despite the alarm often triggered by stock market corrections, such as the one we experienced in August, they are not often tied to major economic crises and are actually quite common.  Without the occasional pullback, stocks may become over priced or inflated, and a bull market swells to a bubble that eventually bursts, thus resulting in a sudden decline across broad sections in the market (known as a stock market crash). We believe that a crash is far more likely than a correction to lead to a bear market (a 20% decline from a recent high). 

Should we fear a market correction?

In August 2015 the Dow Jones Industrial Average, the S&P 500 Index and the NASDAQ Composite Index all fell over 10% from their respective highs. By definition, this qualified as the first U.S. stock market correction since 2011, when these indices declined amid a protracted Congressional struggle over the national debt ceiling and a U.S. credit-rating downgrade. (Source: Based on the performance of the S&P 500 Index, NASDAQ Composite Index and Dow Jones Industrial Average as of 9/11/15.)

By historical standards, we experienced an unusually lengthy period of approximately four years since our last correction (nearly double the average time span between corrections). (See S&P500 chart below.)

Source: SEI, S&P 500 Index as of 8/24/15. Shaded areas represent corrections within the current bull market.

It has been an impressive bull run, in both gains and durability. The S&P 500 has cumulatively gained 189.9% from March 9, 2009 through the close on September 11, 2015. This period ranks fourth for total returns going back to the early 1930s (behind the 1987-2000, 1949-1956 and 1982-1987 periods). At more than 77 months, this bull market ties for the third-longest over the same time frame (behind the 1987-2000 and 1949-1956 periods).(Source: Based on the performance of the S&P 500 Index, including reinvested dividends and capital gains)

China’s role in this recent wave of market volatility

In order to appreciate the factors that initiated this market sell off, we need to understand the current global economic and political landscape at a high level. Leading up to the U.S. housing bubble in 2008 – 2009 and financial crisis a couple years later, our domestic economy was being fueled in large part by leverage. This includes corporate debt, personal debt and government debt. One of the major buyers of our U.S. debt was China. China invested in our debt and we continued to spend, both domestically as well as on Chinese goods. The Chinese economy was growing strongly, with GDP increasing annually between 7-10%, driven by their own population growth and Infrastructure build out as well as the positive trade imbalance with countries like the U.S. The strong growth in China and demand for materials subsequently drove up prices in commodities such as Oil, Steel and Copper. Crude Oil, for example, rallied from the $50 dollar level in 2009 to above $90 per barrel where it remained for a good part of 4 years. (Source: Based on the WTI Crude Oil Spot Price from 1/1/09 to 9/11/15.)

Today, China’s economy appears to be in a state of flux as it transitions to an internally driven economy from one that is supported by foreign capital inflows and infrastructure spending. The slowdown in China started to rear its head last year, however, this Spring is really when we began to see consistently poor economic data coming out of China. Representative of the stock market bubble that burst in China is the Shanghai Composite Index, which peaked at nearly 5,200 in June of this year up 124% over an 8 month period. Three months later, as we look at the index today, it has retraced roughly 40% from the June peak. (Source: Shanghai Stock Exchange Composite Index as of 9/11/15). Specifically, the volatility that occurred on August 20th, 21st, 24th and 25th sent a shock wave through the global markets, leading to the 10% decline we experienced in the S&P 500 index over that period.

The stock market has delivered over the long-term

Many may be tempted to pull out and wait for the market to regain its footing. But moving assets from your current portfolio to what you think is a more stable investment may be a mistake. Amid uncertainty, you need to keep your cool and avoid making potentially costly decisions based on a knee-jerk reaction. While recent weeks have been disconcerting it is imperative to remember and contextualize how markets have recovered after periods of more extreme stress.     

What impact will the Fed decision on interest rates have on the market?

The two day Fed meeting begins on Wednesday September 16th, ending with a Fed decision on interest rates on the 17th. Taken in isolation, it would most likely be a non-event if the Fed decided to start raising interest rates. However, considering what is going on over in China, Europe and emerging markets the decision by the Fed has taken on tremendous weight. In theory, if the U.S. dollar started to appreciate it could have a deep impact on the Global unwind that is currently in place which could potentially hurt our domestic recovery. However, when you look at the current gold, oil and the dollar index a moderate appreciation in the dollar appears to be already priced in. We would not be overly concerned if the Fed decided to raise rates at a modest and gradual pace (which appears to be priced in) and start us on the necessary monetary tightening path.  While this may put pressure on the market, we believe this scenario would play out favorably in the long run. If the Fed makes a move that the markets deem drastic, then we can expect more volatility to ensue.

What to do in a stock market correction?

History suggests that for most people, the answer is to just wait. U.S. corrections generally last about 3 months and despite their regularity, the average annual return for the S&P500 index over the last 50 years has been 9.84%. There is a good chance investment loses suffered in a correction will be recuperated in the long run.  It is our position that if you over react by altering you financial plan and investment strategy, you will likely miss out on gains when the market bounces back. 

As your financial advisors, we are here to give you perspective on what is happening in the markets as it relates to your individual plan. Please do not hesitate to reach out to us if you have specific questions or concerns. 

All the best,
Nathaniel S. Prentice, CFA, CAP® 
Altium Wealth Management

This article is provided solely for informational purposes and may not include a complete discussion of the topics discussed.  The contents of this document should not be construed as the making of any personal investment recommendation or the rendering of any personalized investment, legal, accounting or tax advice.  You should not act or refrain from acting on the basis of the contents of this document without first seeking professional advice.  Nothing contained in this document should be interpreted to state or imply that past performance is indicative of future results.  There is no guarantee that the views and opinions expressed in this article will come to pass.  Investing in the stock market involves various risks, including the loss of some or all amounts invested.  Certain information contained in this document may be obtained from third party sources that we believe to be reliable, but we do not warrant or guarantee the accuracy of such information.  U.S. stock market. Index returns are for illustrative purposes only and do not represent actual fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

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