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This morning's "Daily State" report was penned by Robert Barone (Ph.D., Economics, Georgetown University), a Principal of Universal Value Advisors (UVA) based in Reno, Nevada. We are pleased to be able to offer Robert's views this morning. Dr. Barone's firm focuses on core value investing using Benjamin Graham's "Margin of Safety" approach. We hope you enjoy Robert's take.


Wow! What a few weeks it's been - talk about volatility!

  • The recent "Xoi" (No) vote from the Greek referendum apparently hardened the Greek government's negotiating line;
  • There was an intensification of the meltdown on the Shanghai equity market last Monday, Tuesday and Wednesday;
  • There was a 3 hour trading halt at the NYSE last Wednesday;
  • Then there was a rebound of more than 10% on the Shanghai last Thursday and Friday;
  • And to top it off, by Friday, the Greek government had softened their demands and there was renewed hope for a deal this weekend.

Remember, markets do not like uncertainty, and, as a result, we've seen our S&P 500 index fall 3.6% from 2124 on June 23rd to 2047 on Wednesday and then rebound 1.5% in sympathy with the Shanghai and based on hopes for a Greek deal.

The NYSE

Let's take care of the easy one first - the trading halt at the NYSE on Wednesday. It turned out to be just a glitch in a software upgrade, but early in the day on Wednesday, it wasn't known whether or not this was a cyber-attack. Remember, traders "shoot first" and ask questions later.

Greece

From an economic point of view, the Greek economy is too small to have any significant immediate impact on the U.S. economy, no matter what the outcome of the current drama. There are, however, two worrisome issues which give investors indigestion:

  • A Grexit from the euro also brings along with it geopolitical ramifications, including the likely increased influence of Russia and/or China on Greece;
  • A Grexit from the euro may also serve as a model for the potential exit of the other weak "periphery" countries like Spain, Portugal, and Italy (i.e., so-called "contagion").

China

Between June 5th and July 8th, the Shanghai equity market fell 30% (with a rebound of more than 10% on Thursday and Friday, the 9th and 10th). The worry has been that this contagion will spread to U.S. and other Western markets. While these events are not worry free, I doubt that our markets will react in similar fashion - here's why:

  • The Shanghai market rose 148% from June 19, 2014 to June 5, 2015. Despite the 30% fall, it is still 91% higher than it was a year ago;
  • For comparison, over that same time period, our S&P 500 only rose 6.8%, and, as of this writing on Friday (July 10th), is only 6.0% higher than it was in June, 2014;
  • The Shanghai market is young and has unique and immature characteristics:
    • It is dominated by retail investors who do 80% of the volume;
    • Equity investing is new to the mainland Chinese, and the Shanghai market has been fueled by a huge and rapid influx of eager new individuals;
    • Like in our dot.com bubble, many people in China have quit their jobs to become day traders, a sure sign of a bubble;
    • Retail investors have been allowed to heavily use margin; so think of the panic selling that results when newbie investors get margin calls!
  • The PBOC (People's Bank of China - the Chinese equivalent to the Fed) has intervened to try to slow the equity market decline by putting limits on IPOs, reducing the use of margin, halting trading in about 40% of the market cap, and prohibiting insiders (those owning more than 5% of a company) from selling their shares for 6 months. To some extent, this has worked, as the market, after the Thursday and Friday rebound, is still up 91% from a year earlier. (Lest you think that the PBOC intervention is unusual, think back to '09 in the U.S. when our government interfered in markets with TARP, the prohibition of short-selling, and, of course, several rounds of QE. The PBOC has yet to use QE, and we know that whenever QE has been tried, equity prices have risen!)

The only real worry here, and not a trivial one, is that, should the Chinese equity debacle get out of hand, it might cause a negative impact on China's already weakening economy, and thus have worldwide consequences, as China's worldwide economic influence is at least equivalent to that of the U.S.

As evidence of this fear, June auto sales in China declined 2.3%, the first decline in recent memory. The equity market decline could very well have contributed to the spending decline. While the rebound on the Shanghai on Thursday and Friday has been a relief, volatility in this market may continue to impact western equity venues.

Conclusions

U.S. economic data shows continuing underlying strength in jobs, and emerging strength in housing and consumption. It is even possible that Q2 GDP growth exceeded 3%! A recession, and thus a bear market in equities, is not likely.

But, there are always things to worry about, and we haven't had a significant market correction (a 10% downdraft) in nearly four years. I am not in the prediction business and do not know when such an inevitable correction might occur. Could events in China and Europe cause such a correction? Perhaps. But, a correction is much different than a bear market, and ultimately, corrections always prove to be buying opportunities.

Robert Barone, Ph.D.

Robert Barone (Ph.D., Economics, Georgetown University), an advisor representative of Concert Wealth Management, is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, its management and practices is contained in its "Firm Brochure" (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

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