The long-awaited market correction finally—though fleetingly—arrived in August, with the S&P 500 index declining 13% from the all-time high set in May. September brought some relief, but stocks ended the third quarter down about 6.7% for the year.
Small-caps had a great summer, at least in June and July, with the Russell 2000 up more than 7.5% for the year. The overall market took its toll on the small-caps, though, and the index ended the third quarter with an 8.7% loss for the year-to-date.
The blame, of course, is firmly laid on China, where the stock market meltdown wiped out $5 trillion in market value. Bloomberg BusinessWeek magazine published a cartoon commenting on the search for a scapegoat for China’s woes, an illustration of a goat with a sign reading “HI, I’M DOUG AND I CRASHED THE CHINESE STOCK MARKET.” (This certainly got my attention, though I swear I was nowhere near China at the time!) The article by Belinda Cao summarized the confused reactions of the Chinese government to their market slump, concluding that more volatility is probably on the way before conditions improve.
The exposure to the Chinese market and economy for most U.S. small-caps is pretty limited, but the fall in the small-cap market just goes to show the emotional connection to the global market and economy that investors carry with them like so much excess baggage. Investors have been looking for a correction, and so any trigger will suffice to kick off a decline.
One immediate result of the market’s August swoon is that the Federal Reserve Board delayed the long-expected rate hike at its September meeting. It will take some serious economic and market distress at this point for the Fed to not raise rates at its December meeting, in my view, and the economic situation in the U.S. shows very little weakness that might impede the decision.
While stock market valuations aren’t yet in “bargain” territory, the importance of stock selection in our investing approach remains paramount. The best way to handle the volatility of the overall market is to invest in the highest-quality companies to be found at any stage of the bull-bear cycle, and hold them for the duration.
- DOUGLAS GERLACH