• Investing & Markets

Q3 Review: Seeing The Makings Of A Classic Market Correction

October 9, 2015 | Craig Birk, CFP®

It’s been another whirlwind of a quarter, and as always we’re taking a moment to give you a recap in our Q3 Market Review. Check out the full report here, and read on for a few of the highlights:

Global Stocks
The global stock market fell nearly 10% in Q3, wiping out trillions of dollars of wealth. Some investors who had grown accustomed to gains and low volatility were left shocked. The S&P 500 lost 6.5%. Small caps, international developed and emerging markets stocks fared worse, down 11.9%, 10.2% and 18.0%, respectively.

US Stocks
Within US stocks, there was a hiccup in the momentum trade that had been so successful over the last year. For most of 2014 and 2015, stocks that had been doing well generally continued to do well, while stocks out of favor generally continued to decline. This isn’t unusual, but the severity and consistency has been. Along the way, an increasingly narrow group of stocks have been supporting the US market.

Prior to Q3, Apple, Biotech and a select group of Consumer Discretionary stocks largely drove 2015’s modest gains in US stocks. When stocks began to fall, these segments were hit hard. Apple finished the quarter down 11.7%, not much worse than the overall market, but Biotech as a group was down nearly 20%. This is a classic example of mean reversion, and it illustrates why we seek to maintain portfolios with exposure to high, mid and low momentum stocks. Periodic rebalancing is important, and we urge caution to investors whose portfolios have become concentrated in a few darling stocks.

The Fed
Heading into Q3, the market expected the Fed to initiate an interest rate hike at its September meeting. Anticipation leading up to the event rivaled that of the Super Bowl, but nothing happened. The market rallied momentarily before falling. It is beginning to appear that market participants would now prefer a rate hike with a transparent plan forward over continued uncertainty about if and when lift-off occurs.

Chinese Economy
Many expect Chinese GDP growth to slowly and moderately decline from the current level of around 7%. China remains a centrally planned economy, which has experienced massive growth over the last 20 years, despite rampant corruption. The stories of enormous ghost cities are true, and China’s equity market remains richly valued. China will likely have to deal with a major slowdown and possibly a technical recession.

Actions by the central government this quarter, including the surprising devaluation of the Yuan in August, support our thesis that things are worse than advertised. However, even if China sees harder times, it shouldn’t be disastrous for the rest of the world. If a banking crisis emerges, it wouldn’t greatly impact western banks because Chinese banks are not highly integrated with the rest of the world.

Capital Markets Outlook
In late August, stock market volatility swung suddenly from extraordinarily low to uncomfortably high. For the balance of the year, we expect investors should prepare for something in the middle, with periodic spikes along the way.

What happened in Q3 has all the makings of a classic correction, coming more or less out of nowhere, with steep and quick declines. Roughly two-thirds of corrections fade away quickly, and we don’t see anything suggesting the odds of a rebound this time around are significantly different from historical averages.

Looking ahead, there are a number of bullish and bearish drivers for stocks. China is a major wild card. We’re more pessimistic than most on China, but markets have already priced in significant difficulties. There is upside potential if the country stabilizes and/or accelerates.

For more updates, remember to check out our full quarterly report here.

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