Correction!
The
Dow Jones Industrial Average lost about 6 percent last week. That puts the
benchmark index about 10 percent below its record high on May 19, 2015,
according to Barron’s.
A
drop of that magnitude from a new high may be a correction – a brief but
jarring drop in value that often causes investors to reassess the state of the
market and the health of the companies they hold. If investors judge markets
and holdings to be sound, a correction may represent a buying opportunity. Of
course, there is a chance markets could fall further. A drop of 20 percent or
more is considered a bear market.
The
Standard & Poor’s 500 Index lost about the same amount as the Dow last week
and is down almost 8 percent from its May high. Technically, it’s not yet in
correction territory. A dip greater than 5 percent and less than 10 percent is
a pullback.
Many
factors contributed to U.S. stock markets’ performance last week. Concerns
about global recovery were top of mind for many investors. China’s slowdown may
significantly reduce demand for commodities, and emerging markets that are
dependent on commodity exports are struggling. CNN Money reported:
“China's economic slowdown and currency
devaluation have investors worried that things could get worse as the year goes
on. Developing countries like Brazil and Russia are struggling to revive their
economies as their currencies depreciate dramatically against the dollar.
Brazil's currency value has declined over 20 percent and Russia's over 40
percent, hurting imports and everyday citizens. It's also a huge worry for
America's biggest companies. About 44 percent of the revenues from S&P 500
companies come from outside the United States.”
Currency
depreciation (not to be confused with devaluation, which is a government’s
deliberate downward adjustment in currency value) is market-driven and
sometimes causes investors to pull assets out of a country, which can put more
pressure on the currency.
Uncertainty
about the timing of a rate hike in America didn’t help matters. CNBC reported, after the minutes of the July Federal Open Market Committee meeting
were released last week and indicated “almost all members” had some concerns
about the strength of U.S. economic growth, the CME FedWatch barometer put the
likelihood of a September increase at 24 percent – a 45 percent drop from the
prior day.
From abstract to reality: the potential
effects of rising rates.
When
the economic data align, and the Federal Reserve pulls the trigger on tighter
monetary policy, rising interest rates may affect everything from mortgage
rates to bond yields to economic growth. Here are a few of the possible
consequences:
·
Higher demand for
short-term bonds.
When interest rates rise, bond values fall, and vice versa. However, changes in
bond values will be influenced by the speed and magnitude of the rate change. A
sharp increase over a short period would have a greater effect than a gradual
rise over a longer period. To date, the Fed has indicated the fed funds rate
will rise gradually. Experts cited by The
Wall Street Journal suggest shorter-term bonds and cash will be more
attractive than longer-term bonds for a period of time.
·
Less attractive loan terms
and credit card incentives. By raising the fed funds rate, the Fed will increase
borrowing costs. That’s likely to affect mortgage rates as well as automobile
and other consumer loan rates. The
Journal cautioned homebuyers to be wary of adjustable-rate mortgages and
indicated zero percent introductory offers on credit cards may disappear.
·
Slow improvement in savings
account returns.
Over the longer term, rising rates may prove to be a boon for savers, but there
is likely to be little immediate change in the yields offered on savings
accounts. That’s because banks set these rates. In general, banks raise rates
to attract deposits and few banks need to do that right now, according to an
expert cited by The Wall Street Journal.
While
it seems counterintuitive, tightening monetary policy will not affect interest
rates equally across all markets.
Weekly Focus – Think About It
“The individual investor
should act consistently as an investor and not as a speculator.”
--Benjamin Graham,
American economist
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