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Why markets are down….but not out

Wasps, traffic, reruns, back to school, shark sightings and market corrections. August is fast losing its laid back reputation. The S&P 500 is down around 4.5% for the month and 6.2% from May’s all time highs. Here’s why: 1. Emerging Markets: between commodity falls, political risk, currency devaluations and lower growth, the Emerging Markets are down 22% since April and at 2007 levels.

2. Real Yields: inflation refuses to budge and long term rates are mostly unchanged. This means the real cost of capital increases, leaving companies with less pricing power and consumers facing deflation.

3. Some Bubbles: mostly in the private sector with absurd prices for some tech companies and pre-IPO firms (slow hand clap Uber). One day, investors will refocus on business profitability rather than sales.

4. Productivity: this is a big one. Here’s a messy chart which shows i) growth of the labor force added to ii) growth in productivity which guides us to iii) growth in GDP.

Markets Down But Not Out Chart

They should track each other and, indeed, the Fed uses the labor force+productivity equation as a growth proxy. Right now, labor force growth and productivity barely touch 1.5% and growth has inevitably slowed. You would think with all the technology, labor displacement talk, smart phones and shared economy themes, productivity would soar. But it is not the case. And that makes investors nervous.

So, if you add all these together and throw in August volumes, European vacations, bank and public holidays, there are simply not many people around to take the other side of the trades.

Bottom Line: these are testing times. The most telegraphed rate hike ever may happen this year but it is priced in. We’re fine with current valuations and see no reason to reallocate assets.

--Brouwer & Janachowski, LLC

Please note that the discussion of the investments and investment strategy of Brouwer & Janachowski, LLC (“Advisor”) (including Advisor’s research and investment process) represent the investments and investment strategy of Advisor at the date of this commentary, and are subject to change without notice. Advisor cannot assure that the type of investments mentioned in this commentary will outperform any other investment strategy in the future, nor can it guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.

Advisor cannot guarantee the accuracy or completeness of any statements or numerical data in this commentary. Past performance is no indication of future results.