West Oak Capital, LLC
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October 2015

We welcome your call or email if you have any thoughts you would like to discuss.

Byron, Lisa, Jerry and Darin
Stock prices staged a broad retreat in recent weeks on concerns that growth around the world is slowing.  While such uncertain moments are normal for the capital markets, it has been about four years since the last time investors had to contend with a setback of this magnitude.  Headline news stories are pointing to events in China, but we believe China is a symptom rather than the cause of tentative conditions.  Like water sloshing back and forth in a tub, consequences of the 2008 credit crisis are still resonating.  It remains an open question as to how the Federal Reserve will successfully extricate itself from a historic program of monetary stimulus.
There are many arguments about where to place the blame for the credit crisis, although it is clear that the housing party came to a jarring halt in 2008.  Mortgages became toxic for the financial services companies that held them.  Market values collapsed, and our economy abruptly stalled.  The solution was to pump enormous amounts of money into the system to get it up and moving again.  The Federal Reserve dropped interest rates to zero and began a program of printing money and buying bonds in the open market to keep rates low for borrowers.  The government propped up the banks with extraordinary loans to keep them solvent.
The plan worked.  Economic conditions slowly improved, corporate profits recovered, the banking system breathed new life and the employment picture gradually brightened.  The controversial stimulus program turned out to be a profitable endeavor for taxpayers and investors.  It is a happy story, so far, but it is not over.  We essentially transferred the liquidity crisis from individuals and corporate balance sheets to the Federal Reserve. The Federal Reserve is the best entity on the planet to deal with the issue, since they control the printing press that produces the world’s most prominent reserve currency, the U.S. dollar.  However, we are only mid-way through this monetary experiment, as the Federal Reserve needs to move the needle back toward a normal interest rate environment and figure out what to do with roughly $4 trillion worth of bonds that they bought in recent years.  Can they do it without messing up the progress we have made, and does the U.S. now find itself beholden to weakening conditions in other parts of the world?
Countries are taking cues from our playbook.  China is devaluing its currency to prop up its export business, while Europe and Japan are engaging in a version of our “quantitative easing” program of buying bonds on the open market to keep interest rates low.  These steps worked for the U.S., so perhaps it is no surprise that other parts of the world are trying them as well.  This presents a headwind for our domestic companies, because the stronger U.S. dollar makes it harder for U.S. companies to sell products to foreign customers.  Revenues for companies that comprise the S&P 500 index have declined by roughly 2.8 percent from a year ago, and analysts have trimmed their 2015 estimates for S&P 500 profits by about 5.5 percent.  A slowdown in the corporate sector dims the outlook for new job creation.  The Federal Reserve apparently took recent global events into consideration when they chose to delay raising short-term interest rates at their September meeting.  Progress here at home is being impacted by events abroad.
One area coming under suspicion is China, a country for which economic data is about as clear as the smog-filled air in Beijing.  Economists have a general impression that the rapid growth of recent years is showing signs of fatigue.  The Chinese government has taken actions that indicate a response to weakening conditions, while their stock market experienced a speculative surge and collapse.  Trouble in the world’s second largest economy makes headlines, although we do not believe it explains the selloff in our domestic stock market.  China represents only two percent of the earnings of companies in the S&P 500 index.  The entire value of the Chinese stock market is little more than two percent of the world’s total, while the U.S. represents 52 percent of the global stock market value.  Less than one percent of our $18 trillion U.S. economy comes from exports to China.  We import roughly three times as much as we export to them, so, in this case, the stronger dollar would appear to be a net benefit to the U.S. as Chinese goods become less expensive for American consumers.
Rather than wag our finger at China, it seems more likely that capital markets are struggling with the fundamental outlook for interest rates, corporate profits and employment.  There are real headwinds buffeting these key metrics right now, and the closely-watched actions of our Federal Reserve appear to be at the center.  Geopolitical events in Greece, Iran, China and now Syria only add to investors’ concern.  Depending upon one’s point of view, the 2016 U.S. Presidential race has introduced either a great amount of entertainment or outright confusion regarding future policy direction of government agencies that are in a powerful position to influence the economy.
Turbulent market conditions can be difficult for investors, although the recoveries are often just as unexpected as the setbacks.  We encourage you to call us if you have any concerns you would like to discuss. 

Past performance is not indicative of future results. The information contained in this report is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the items mentioned. The information, while not guaranteed as accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.
West Oak Capital, LLC
2801 Townsgate Road, Suite 112
Westlake Village, California 91361
Ph. 805.230.8282, Fax 805.230.8283
Copyright © 2015 West Oak Capital, LLC, All rights reserved.

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