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Stocks Slide Amidst Global Turmoil

Market Digest – Week Ending 8/1

Stocks declined this week, surrendering all gains for July in the process. Many culprits were fingered, including escalating conflict in Gaza, tensions with Russia and debt default in Argentina. Meanwhile Q2 US GDP growth was reported at a robust 4% and the economy added over 200,000 jobs for a sixth straight month. The Fed continued bond tapering but gave no indication of a change in long term strategy. Most likely, the market just needed to let out some air and was pushed by one or a few big sellers. Bonds, gold and oil also fell.

Weekly Returns:

S&P 500: 1,925 (-2.7%)
FTSE All-World ex-US: (-2.3%)
US 10 Year Treasury Yield: 2.50% (+0.03%)
Gold: $1,293 (-1.1%)
USD/EUR: $1.343 (0.0%)

Major Events:   

  • Monday –Dollar Tree agreed to buy Family Dollar for $8.5 billion.
  • Tuesday – The US and EU adopted a wide range of sanctions against Russia, though most did not expect them to dissuade Russia from further intervention in Ukraine.
  • Tuesday – The Telecommunications sector rose 2.2% after Windstream announced a plan to spin off some assets in the form of a REIT, which would lower taxes. It was expected other companies may also utilize the tactic.
  • Wednesday – The Fed gave a modestly more upbeat view of the economy but did not make major adjustments to its bond purchase tapering or interest rate outlook.
  • Wednesday – S&P declared Argentina in default after it missed a bond payment.
  • Thursday – US stocks suffered one of their worst declines in recent memory, with the S&P 500 dropping 2.0%. The Dow Jones Industrial Average fell into negative territory for the year.
  • Friday – The US economy added 209,000 jobs, marking it the first time since 1997 that over 200,000 jobs have been added for six straight months. The unemployment rate rose to 6.2% from 6.1% as more workers entered the job force.

Our take:

Preliminary Q2 GDP growth was reported this week at 4.0%, the highest we’ve seen in some time. The economy added over 200,000 jobs for a sixth straight month. And earnings results continue to be mostly ahead of expectations. Yet the S&P lost 2.7% for the week.

Why? The US recovery is now well accepted and people are expecting decent results. At least regarding the economy, the mass-pessimism which dominated most of the last five years is gone. This sets the bar higher and makes it harder for the economy or companies to surprise to the upside. Does this mean it is time to sell? No, we don’t think it is time to sell. But we are due for a correction. Sentiment on the economy is much more positive but there is still a lot of skepticism about the stock market. Few expect big gains and many are scared of buying at a high. Bull markets usually end when greed is pervasive. Right now it is not. Markets tend to lead the economy by 0-12 months or so, so we could see a stock decline before we notice the next recession, but momentum seems too strong right now to expect a recession in the next year.

One potential area of concern – small cap stocks are getting hit. The Russell 2000 Index is down over 4% year to date. Small caps led most of the bull market, so weakness could be the canary in the coal mine for the rest of the market. But most likely the valuation gap between small cap and large cap stock is simply correcting itself. We believe an allocation to small cap stocks continues to be important for long term investors, but caution against excessive weightings.

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