World stock prices have been volatile lately, and China’s crashing stock market has been in the front seat of the roller coaster. Many investors are worried that China’s economy is slowing down significantly faster than reported, and that a hard landing in the world’s second-largest economy will pull the global economy into recession with it.

For years, China has been the main economic-growth engine for many developed and emerging markets around the world. Latin America, most of Asia, parts of Africa and beyond have supplied the raw materials needed to fuel the economic boom in China. Mega-cap multi-national companies from developed economies have also prospered by tapping into China’s industrial revolution. Despite China’s impressive economic growth over the years and its impact on countries around the world, investing in China has been unconventional and guarded.

With the support of the central government, local investors swiftly bid the market up this year.  The Shanghai market was up nearly 60% during the first six months of 2015 alone. Yet, the explosive growth had almost no impact on U.S. stocks. The S&P 500 traded sideways during the period. Moreover, when the Shanghai market tanked in July, U.S. stocks continued to be flat.  The chart below is a terrific pictorial on what a classic bubble looks like; happily, it didn’t involve U.S. stocks.

Source: CNNMoney, For Informational Purposes Only

U.S. stocks didn’t react to China’s news and markets until recently.  We believe the recent correlation to China’s stock market is temporary, and that U.S. investors have become more sensitive to other risks as we approach a key Federal Reserve meeting on interest rates. The Fed has indicated that it plans to raise rates at some point this year, and the September meeting has been targeted by many analysts as the date of the first increase in over a decade.

The potential of raising interest rates in the U.S., while China is retrenching and pulling many emerging markets down with it, has become a reason to take profits for many investors. However, the recent volatility has also spurred a wave of new money entering the markets. U.S. stocks have avoided a correction (a drop of at least 10%) since 2011. A four-year run without a correction is unusual for the U.S., and there seems to be pent up demand on the sidelines that has been waiting for entry points.

The Chinese Transition Redux

The points below are a few basic elements to summarize the ongoing dialogue we will see about China over the coming year.  The media will likely focus on these issues:

• Chinese economy moving from export based economy to a balanced economy – “a consumer driven economy.”
• The transitional changes will be challenging and investments in China will be volatile.
• China’s attempts to stabilize markets have not been as effective as hoped.
• Reduced appetite for commodities and thus lower worldwide inflation is likely.

The U.S. Federal Reserve may be on hold for a while longer.  Low inflation is good, but deflation is not. If the Fed raises rates in September, it could be taking a big risk of tipping prices into a deflationary zone and strengthening the U.S. dollar. If the Fed leaves interest rates unchanged, Fed members will have more time to analyze data and let the economy further develop some employment and price trends.

We know volatility can be unsettling; regardless, our long-term outlook is still positive. We believe investors who have sufficient diversification and flexibility in their portfolios should be able to successfully navigate these choppy waters. To see if your portfolio is properly balanced based on your long-term goals, contact our team to assess your needs. Now is the time to review your situation and make adjustments accordingly to help mitigate your downside risks.

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