The Markets	09/30/15 Close	06/30/15 Close	3rd Qtr. Change	09/30/14 Close	12 Mo. Change	YTD Change
Dow	16,285	17,620	-7.58%	17,043	-4.45%	-8.63%
NASDAQ	4,620	4,987	-7.36%	4,493	+2.83%	-2.45%
S&P 500	1,920	2,063	-6.93%	1,972	-2.64%	-6.75%
MSCI EAFE	1,644	1,842	-10.75%	1,846	-10.94%	-7.38%
10-yr Treas. yield	2.06%	2.34%	-0.28%	2.51%	-0.45%	-0.11%
Fed funds rate	0 to.25%	0 to.25%	n/a	0 to.25%	n/a	n/a

(stock indices are before dividends; yield and rate changes are absolute changes)

The quarter was dominated by stock market turmoil and indicators of slowing growth in China. Along with mixed economic data in the US, domestic stock markets turned in their worst quarter since 2011. August was the worst month for the Dow and S&P 500 in three years and was also the most volatile month in four years. After actually increasing to 2.43% early in July, the benchmark 10-year Treasury slipped to 2% in August and treaded water through September. International stocks resumed their slide as the crises in the Middle East kept pressure on Europe and Asia caught a cold from China.

The Chinese government repeatedly demonstrated how market intervention just makes things worse. After years of encouraging stock market investment by its unknowledgeable citizens, China went to great lengths to try and prop the market up. First, the government bought billions of dollars of Chinese stocks. Then they devalued the Chinese currency by 2%, the first devaluation since 1994, stoking fears of a currency war and driving other emerging market currencies down even further. (Kazakhstan’s currency fell 25% and Vietnam devalued their currency by 1% against the US dollar, the third time this year.) The Chinese central bank cut interest rates and lowered bank reserve requirements and then expressly forbid some large investors from selling stocks under threat of imprisonment.

After the continuing slide in oil prices and concern about the timing of a Fed rate hike and contraction in China’s factory sector, the Dow was down 5.8% for the week ending August 21 and entered “correction” territory of a 10% decline from its recent high. The “VIX”, a measure of volatility commonly thought of as a “fear gauge”, was up 100% for that week. Over the weekend those fears grew and the Dow opened down 1,000 points on August 24. It recovered around half of its initial loss by day’s end but China was down another 9%. Despite the safeguards put in place after the “flash crash” in 2010, trading was disrupted and many stocks and exchange-traded funds fell more than the overall market for no apparent reason, further undermining confidence.

The drama in Greece reached some measure of resolution with a deal from the EU. The Greeks agreed to pension reform and an increase in the value-added tax from 13% to 23%. The EU will provide over $90 billion over three years while the Greeks will create a $50 billion “asset trust” of various assets to be sold and privatized. Two weeks after Greek voters turned down an austerity plan the Greek government passed an austerity plan. This forced elections in September elections (Greece’s fifth in six years) and the left-wing Syriza party and their leader Alexis Tsipras were re-elected by a larger margin than expected.

The initial estimate for second quarter GDP growth was 2.6%, an improvement from the first quarter’s 0.6%. Later revisions increased GDP growth to 3.7%, an encouraging development, with higher consumer spending and business investment. Employment data was again mixed, with initial jobless claims year-to-date at the lowest level since 1973, when the workforce was 40% smaller. But the September jobs report was disappointing with only 142,000 jobs added and August job growth revised downward. Unemployment stayed at 5.1% but labor participation continued to slip and hit a new low of 62.4% Housing prices kept growing but at a slower pace, up around 5% from the prior year in July. Sales remained strong, at an eight-year high in July, and inventory was low at less than the normal six months.

On the political front, a deal was reached with Iran over their development of nuclear weapons John Boehner resigned as speaker of the House and a government shutdown over funding of Planned Parenthood was averted, at least until Dec. 11, with an interim agreement.

Looking Forward

It’s usually best (certainly more interesting) to have a specific data point or event in Looking Forward, rather than some vague sentiment or broad measure. However, we are probably at the point where such a broad measure could either calm or inflame the growing fears of an economic slowdown.

The third quarter gross domestic product (GDP) readings, and subsequent revisions, will be critical. The pundits can analyze every piece of data and every geopolitical development along the way, but if GDP shows strength and revisions from the initial estimate are either flat or positive the tide will likely subside.

Of course, there are other broad indicators that could serve the same purpose but GDP really captures plenty of information and economic impacts. It is a lagging measure for sure, with the initial estimate to be released around the end of October for the quarter ended September. Still, third quarter GDP will illustrate the real impact of slowing Chinese growth, slowing employment growth, crumbling commodity prices, the strain of the refugees crisis in Europe and the effect of the stronger dollar on exports. Whew!

And it’s still hard not to include the Fed here since they are back on the front pages. Following the September jobs report, futures markets indicated there is virtually no expectation that the Fed will increase interest rates at the October meeting. The likelihood that rates will be raised by year-end went down to 30% from 50%. At least that’s what the market is saying, and they never get it wrong (sarcasm intended).

It would be interesting if the debate included some analysis of whether a 0.25% increase in interest rates would really make any difference, offset by the benefit of the markets no longer reacting so strongly on every tiny development and speculation regarding a rate increase. Nobody seems to be saying that such a small increase would unreasonably increase borrowing costs or curtail lending and borrowing; in fact, the fear seems to be that any increase will burst whatever asset bubbles are out there. There are some voices saying that the true danger of raising rates is if the Fed continues to raise aggressively once they start.

Our Portfolios

The list of risks for investing in stocks is as long as your arm. This quarter presented a perfect example of three major levels of risk.

Market risk (also known as systematic risk) is perhaps the broadest level, and is based simply on being involved in a particular market. It can’t be avoided by diversifying through additional investments in the same or similar markets and can be influenced by overall economic activity, geopolitical issues, valuation, investor sentiment and a wide range of other factors. As the saying goes, a rising tide lifts all boats, and a receding tide certainly lowers all boats, as this quarter’s market performance clearly illustrates. The difference is that market risk is unpredictable and can be more drastic than the tides at the Bay of Fundy.

Sector risk (also known as industry risk) is due to factors that have a greater impact on a particular economic sector or group of companies in the same industry. The growing popularity of sector exchange-traded funds makes industry concentration much easier and many investors inadvertently find themselves exposed to this risk by pursuing some other narrowly focused strategy. For example, income-hungry investors often end up with portfolios that are heavy in just a few sectors (energy partnerships, utilities, real estate, etc.). Sectors can move independently of the overall market and this is the allure of sector-oriented investing. Unfortunately, sectors can also be even more volatile than the market. Energy investors know this all too well, with the fall in oil prices causing US energy stocks to decline more than twice the S&P 500 this quarter and more than three times year-to-date.

Company risk (also known as specific risk) comes from owning the stock of an individual company. External or internal factors can affect a company’s profitability and reputation but the possibility of big returns is so attractive that investors keep buying individual stocks. That behavior is encouraged by brokerage firms and self-described successful stock traders as well as the notion that it must be simple to pick obvious winners and avoid obvious losers. In the real world crazy things can happen to a company – management incompetence or turmoil, fickle consumers, product obsolescence, regulatory problems, legal issues, predatory competitors, etc. A number of these problems converged when Volkswagen was caught cheating on emissions software in 11 million diesel vehicles and the stock fell nearly 40% in just the last two weeks. Volkswagen’s behavior was so brazen that it could spell the death of the concept of “clean diesel” and could cost it untold billions of dollars as well as potential criminal penalties.

We are happy to accept market risk because we believe that investing for the long-term will ultimately help smooth out the ride, even as we acknowledge gains in any given period are certainly not guaranteed. After all, willingness to bear risk is the reason stock investors “get paid” over the long run. Broad diversification through index funds helps diffuse sector risk and company risk and is just one of many reasons we do not advocate trading individual stocks. Even when using actively managed funds we employ multiple funds with the objective of creating the opportunity for the separate funds to perform well but to still avoid heavy concentration in any one sector.

Hope for the Best (Plan for the Worst?)

No one gets married assuming or planning they will get divorced. But unfortunately, divorce affects nearly half of marriages. From the July 2015 Divorce Financial Analyst Journal, following are nine financial mistakes typical of divorce.

1. Being in the Dark – It is very common that one party handles the finances and the other has no clue what is going on. Not only is it hard to catch up in the midst of a divorce but this situation naturally leads to mistrust, whether deserved or not.

2. Focusing Small – Rather than being concerned with the bigger financial issues, emotions often cause divorcing parties to spend a lot of time and effort (and money!) on small, inconsequential items.

3. Thinking Only in the Short-Term – A divorce settlement has serious implications for long-term financial success, and not considering the costs and benefits of various decisions like keeping a house can be financially fatal.

4. Ignoring Reality – The simple truth is that it costs much more for two people to live apart than together, and assuming that a certain lifestyle can be maintained is dangerous. If possible, it’s far better to “start from scratch” and create a new lifestyle within the available resources.

5. Seeking Revenge – Regardless of how badly someone has behaved, spending time and money trying to inflict pain just uses time and money and rarely leads to any real satisfaction.

6. Neglecting Your Homework – Even when the settlement is final, there is still plenty of work to be done. Estate planning documents, employee benefits and insurance policies should be reviewed for changes in beneficiaries or other adjustments.

7. Believing Your Attorney is a Financial Expert – Take it from a Certified Divorce Financial analyst, most attorneys are not that financially savvy. A good attorney will recognize that and recommend that a client confer with a financial planner if necessary.

8. Letting Debt Linger – Even if the settlement says one party is responsible for paying marital debt, it has no impact whatsoever with creditors and they will pursue both parties if the debts are not paid. If possible, it is far better to use marital assets to pay off debt or to sell assets (like a house) that have debt attached and then start over separately.

9. Failing to Cover Your Bases –If spousal support or child support is a major part of the settlement, a life or disability insurance policy on the payer can guarantee that the payments continue.

Not surprisingly, the concepts and behaviors that can prevent these mistakes are very similar to prudent financial management for anyone. Taking an active role in your finances will pay off in every situation.