Galvin, Gaustad & Stein, LLC

Current Market Environment - January 22, 2016

In light of current market conditions, we have put together some brief thoughts below that will hopefully add some clarity and help answer questions that might exist. As always, if you would like further information regarding the current situation or how it impacts your portfolio, please don’t hesitate to call or email at any time.

The recent market sell-off is primarily due to global growth concerns, in particular surrounding China. Recent metrics for the US, EU and Japan still point to continued slow growth, and global central banks are still supplying the world with ample liquidity and rock-bottom interest rates. Oil/commodity prices are at very low levels, and while this paints a worrying picture, keep in mind that the major global economies of the US, EU, China and Japan are all net commodity importers, so this should actually help developed-country growth. JPMorgan analysts put out a detailed report on 1/14/16 concluding the continued slump in oil prices is still mostly driven by excess supply rather than decreased demand, and they therefore expect low oil prices to add a positive 0.5% to global GDP growth in 2016. Also note that China is a net exporter to the US and thus a lower Yuan exchange rate is a net benefit for the US economy overall.

The situation in China is not perfectly clear, which is a primary reason for the selling as uncertainty lends itself to panic. What we do know is that official economic statistics out of China show signs of a slowing economy, but are not terrible and do not justify the current level of selling. The main cause has instead been the response of the Chinese government to the drop in their stock market and economic slowdown. The response has seemed overly desperate at times and this makes people wonder if things are worse than they appear on the surface. The signals out of China are not all negative. Air China recently put in another order for Boeing widebody jets; Starbucks CEO Howard Schultz gave the following quote to the WSJ on 1/12/16: “We have confidence in the future of the Chinese economy, despite all the rhetoric, noise and issues…People are looking for reasons not to believe. I’m on the ground and I see firsthand. I am bullish;” and Nike was very positive on China in its latest quarterly earnings update on 12/22/15, as Chinese revenue was up 24% for the quarter and its future business is expected to be up 31%.

It is also important to note the differences between the current situation and what drove the US market down over 40% in 2008. The largest difference is health of the global banking system. In 2008, the housing crisis helped precipitate a near-global catastrophe by causing a number of large bank failures, necessitating enormous government bailouts to stave off total financial collapse. This occurred because banks were not allocating enough reserve capital to cover their losses on these reckless loans. Today, the Federal Reserve and global banking regulators have introduced much higher capital standards for the world’s biggest banks and loan standards have remained much tighter than in the 2006-08 period. It is true that a few regional banks will be hit hard by loans to struggling oil & gas companies, but the nation’s largest banks are in good shape and should not produce the systemic effect that occurred in 2008. Another key difference is that the collapse in energy and commodity prices is, as mentioned above, actually a net positive for most of the developed world, whereas the housing market downturn was a clear negative.

At GGS, we take a long-term approach to investing in the stock market and do not attempt to engage market timing by raising large amounts of cash when things look bad. Indeed, when things look bad and investors are highly pessimistic (such as right now), it is often a good time to be buying into the market or repositioning portfolios to give them the best chance for future success when prices recover. Things are often not as bad as they appear, and climbing over these “walls of worry” (Greece, Ukraine, US debt ceiling, end of Fed QE, Ebola, very similar China worries last Aug/Sept) has helped propel the stock market higher the past few years. The market certainly can have significant drops and we are not calling a bottom to the current decline, but in general the best long-term strategy for making money is to stay continuously invested in high-quality companies.

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