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From The No-Load Fund Investor, 9/15...
The stock market performed poorly in August. The S&P 500 fell about 6% and by the end of the month had landed in correction territory, with a 10%-plus decline from its 52-week high. Virtually all types of stocks experienced significant declines.
World equity markets fell because of investor reaction to slowing economic growth in China and fears of rate increases in the U.S. The carnage began with a crash in the Chinese stock market and a move by the Chinese government to decrease the value of the country’s currency, which it hopes will improve the competitiveness of their export sector. This augurs tougher times for other large Asian exporters as well as countries and companies elsewhere in the world that export natural resources to China.
The Chinese stock market actually represents a very tiny fraction of the country’s total economy and moves much more based on Chinese investor psychology than on the condition of the Chinese economy. Worldwide reaction to the Chinese market correction is vastly out of line with the reality of its inner workings. A crash in China and big corrections in the developed world are not justified by an estimated decrease in the growth rate of the Chinese economy to somewhere around 4% from previous targets of 7%.
The odds are about 50/50 that the Federal Reserve Board will increase one or more of the interest rates under its control in late September. Based on the economic data, they certainly don’t have to. We don’t, however, expect the central bank to embark on a significant new phase of higher rates. The most likely scenario is a tiny increase of as little as 0.25%, followed by a lengthy “wait and see” period that will be telegraphed in advance and designed to preclude any heinous shocks to the market.
China and Best Buys
Investors in Chinese companies have been battered in recent weeks. Since reaching a high in mid-June, the Shanghai Stock Exchange Composite has plummeted 40%.
Combined with a depreciation of the Chinese currency and other governmental moves meant to stimulate the economy, the fall in Chinese stocks has rippled through the stock markets of other countries. Broad indexes of emerging markets have dropped approximately 17% over the past several months, as slower Chinese growth limits demand for exports from other emerging countries, especially of various commodities formerly in demand as inputs for Chinese construction projects. Even the U.S., which exports relatively little to China, has been hit, with broad indexes of its stocks down more than 10% from their highs reached in late July. Given these drops, it would be natural for American investors to worry about their own exposure to stocks in China as well as spillover effects from slower growth there. Of particular concern would be stocks with above-average exposure to China and international trade, as such companies would be expected to fall more than ones that achieve most of their sales and profits in the U.S.
We diversify our Best Buys models across funds that include equities of various sizes and types, and from a host of regions, shading our recommendations toward those areas that we find most attractive. In 2015, this has meant, among other things, that we have favored U.S. stocks over foreign ones, and developed markets over emerging. We are doing so mainly because despite its problems, the U.S. continues to provide the best combination of growth potential, liquidity and political stability, and isn’t valued too richly relative to the rest of the world.
Best Buys also reflects a preference currently for the ‘growth’ style of investing over the ‘value’ style, though the degree to which depends on the particular model. Growth funds tend to have less than value funds in those segments of the market that have been the weakest recently and are particularly vulnerable to a slowdown in China: energy and materials. Additionally, they usually offer more exposure to healthcare and other companies that are considered more immune to global economic headwinds.
Even so, given our historically buttressed belief in diversification, we have not abandoned emerging markets and especially the value style altogether. All but three of our 25 Best Buys models contain at least one foreign or global stock fund, each one of which has at least a little direct exposure to emerging markets. Best Buys also includes three U.S.-focused funds that have at least 3% of their portfolios in emerging markets.
You can read more of our analysis of China and emerging market investment exposure and impact in the September issue of The No-Load Fund Investor.
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