China may pressure stocks for some time

By Covestor

The markets sent investors on a wild ride last month as the broader indices experienced heavy losses and then rebounded sharply but still ended at their respective lowest monthly close for the year.

The S&P 500 fell 6.26% for August, at one point having lost 11.17% intra-month, with the Dow and NASDAQ shedding 6.57% and 6.86%, respectively.

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It was the worst single monthly performance since May of 2012.

China

The crisis in the Chinese stock market finally reached domestic markets, with a massive selloff triggering a brief panic on Wall Street before a rate cut by the Chinese government seemed to temporarily assuage investor fears and return some normalcy to the markets.

Commodity prices followed a similar pattern as Chinese demand concerns impacted the global financial marketplace, with oil and gold experiencing wild swings for the month.

The Fed was once again in the spotlight as September 17th marks the date on which interest rates are expected to be raised, but the recent turmoil could delay that action as inflation struggles to reach the 2% target mark and economic data remains tepid.

Volatility

Volatility soared in August as well, with the VIX leaping over 134% to end the month at 28.43, although down from its earlier high of 53.29.

Overseas, China was the single biggest impact in the global financial markets for August.

The Shanghai Composite Index fell 12.46%, and the decline was only halted after Chinese officials cut interest rates and announced further stimulative actions intended to inject liquidity into the fragile Chinese economy.

I believe that the long term impact of China’s slowing economy could keep volatility high in equities and depress commodities for some time.

Europe

Meanwhile, Europe showed some economic resilience as inflation came in at a low but stable 0.2% for August.

However, the Eurozone disappointed with a lower-than-expected 1.3% growth rate in the second quarter and could face more challenges if Greece becomes a threat again.

Japan also showed signs of trouble as the economy contracted by 1.6% in the second quarter and the lack of positive economic data put a damper on future growth expectations.

Oil Slump

August was another tough month for commodities thanks largely to the Chinese crisis.

Oil touched a low of $37.75 per barrel before rebounding to end the month at $49.20 – up 3.51% for the month.

From my perspective, the volatility isn’t over for black gold either, as the fallout from decreased Chinese demand has yet to be fully digested by the global marketplace.

Natural Gas

Natural gas ended the month of August only slightly lower at $2.69 MMBtu (million British thermal units), down 0.99%.

Gold gained 3.42% for the month as volatility soared and investors sought protection in the safe haven asset.

The precious metal awaits a Fed decision regarding interest rates before any further moves are expected, in my opinion.

Dollar

The US dollar finally tumbled somewhat this month against the euro and yen as domestic markets collapsed and brought to question what the Fed will do regarding interest rates in September.

The yield on the 10-year treasury ended the month essentially flat after dropping to just 1.91% intra-month before regaining ground.

I believe that heavy volatility will likely carry over into September as investors await word from the Fed regarding its next move and what the decision will be about interest rates.

Outlook

Further downside is still possible in the Chinese economy and the weakness in Europe and Japan in the second quarter could be indications of problems that may come to light over the next few months.

Investors are cautioned to watch the upcoming jobs and inflation data as clues of what direction the Fed will ultimately take.

Portfolios Recap

Tactical Long Short Strategy: The strategy outperformed the market, returning -5.83% after fees vs S&P 500 at -6.13% for the month of August, buoyed by the 5% cash buffer.

We stayed long in this strategy for the month and overall performance was hurt by the S&P 500 selloff driven by fear and panic due to the Chinese stock market crash and commodities price drop.

Although the algorithm signaled to go short on Friday, August 21st, we decided to stay long because the market pullback was due to overseas news and commodities, outside of S&P 500 earnings and US fundamentals.

This turned out to be the correct move, for the pullback proved to be a temporary one as the markets quickly rallied the following week. If we had shorted, we would have suffered a loss of 0.77% from August 21st to 27th, losing out on the market recovery. Instead we gained 0.77% participating in the rally, generating an alpha of 1.55% for overriding the signal during this time period.

Equity Opportunity Strategy:  The Equity Opportunity portfolio returned -6.54% this month. Most equity positions were down due to the market pullback.

The healthcare and media sectors, which we have exposure to, suffered a correction in August due to being overvalued before, which hurt overall performance.

The biotech sector had been up over 400% since 2009 and were due for a correction.

The two positions that suffered the most were Amgen Inc. (AMGN) at -14.05% and Walt Disney & Co. (DIS) at -15.10%.

This strategy has downside protection in the ability to invest up to 10% in the ProShares Short S&P 500 Index fund (SH).

Additionally, the portfolio holds bellwether meg-acap names which are expected to weather downturns better than the overall market.

Tactical ETF Strategy:  The strategy returned -5.81% in August. Our ETF portfolio was weighted towards US Equity ETFs comprising 77.49% of the portfolio, while international equities were allocated at 15.14%.

The majority of the portfolio was invested in diversified equities which were hurt overall by the US and Chinese market pullbacks.

The strategy has downside protection in the ability to invest up to 30% in SH. 10% of the portfolio can also be opportunistically invested or kept as cash in order to give the portfolio additional flexibility during this period of volatility.

Alternative Sector Rotation Strategy: Because of the drop in commodity prices and a strong US dollar, we expect to see most alternative assets to continue to be weak and under pressure.

We have been holding 100% cash in this strategy and thus were not affected by the recent market pullbacks. We will continue to monitor the market closely to determine future allocations in this strategy.

Photo Credit: Wilson Hui via Flickr Creative Commons //

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The post China may pressure stocks for some time appeared first on Smarter InvestingCovestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures.