Equities took a pounding this week as the slowing Chinese economy rattled commodity markets. Weakness in credit markets, a result of falling commodity prices, are also raising questions of solvency for some resource producers. The price of West Texas Intermediate Crude oil briefly traded below $40, a new low in 2015, while industrial commodities such as copper also weakened. For the week, the S&P 500 Index fell 5.8 percent and the Nasdaq lost 6.8 percent, wiping out all of its gains for the year.
China provided two negative data points this week.The stock market returned to its 2015 lows, erasing the boost from the government’s multiple bailout efforts. Additionally, the flash PMI for August fell to 47.1, the lowest level since the beginning of 2009. Any number below 50 signals contraction in the manufacturing sector. This rattled everything from commodities to emerging market currencies as many investors now expect further depreciation of the yuan.
As for the bond markets, corporates have been under pressure since May. These bonds haven’t been taking significant losses but there has been a steady downtrend as investors are worried that low oil prices will impact the energy sector. Some firms have borrowed to fund their operations and low oil prices could push some smaller firms into bankruptcy, as has already happened in coal this year.
Federal Reserve minutes caused investors to worry about delayed rate hikes due to a weaker economy. Fed officials discussed China, the strong dollar and weak commodities as possibly leading to slower economic growth. China is only mentioned 6 times, twice as a potential risk. In contrast, the word “reinvestment” appeared 13 times and was the second topic of discussion at the meeting. This is very important because the Federal Reserve has said it will stop reinvestments “sometime after” it begins raising interest rates. A rate hike could be delayed if economic growth weakens, but the Fed didn’t appear concerned three weeks ago. Fed officials instead spent a considerable amount of time discussing what they will do after rate hikes. Given the temperamental environment, events impacting the Fed’s direction may unfold, though a September rate hike is still a strong possibility.
There was significant panic on Friday and the market dropped as investors hedged against further losses by buying options at the close of the trading day. This is clearly an emotional reaction and signals selling may have climaxed. Several important sectors such as the market leading biotechnology sector, healthcare and consumer discretionary dipped to their 200-day moving averages, a key support line that has held for several years.
Currently, the market is oversold, suffering one of its worst weeks during this bull market. The dip this week resembles the drop seen last October, when stocks fell by a similar amount over the course of a few days. That decline was followed by a sharp rally and resumption of the bull market. Investors tend to overreact and the events of this week will likely lead to a rebound over the coming days. We would encourage investors to not overreact; instead, this may be an excellent buying opportunity as we enter the fourth quarter.