Global markets finished Q3 on a low note with the TSE down just over 9% in the first 9 months of 2015. Fears over slowing global growth once again took center stage with much of the concern centered on China. As the world’s second largest economy, concerns around slowing Chinese growth escalated in August when the Chinese stock market began its dramatic descent. After appreciating about 70% in less than 9 months, the speculative bubble began deflating in July and gathered momentum in August with some days witnessing drops of close to 10%.

For some reason, the world decided that a falling Chinese stock market implies a faltering Chinese economy even though the market didn’t make the same conclusion during the stock market run up. When the Chinese markets kept climbing earlier this year, I didn’t hear any commentary around how that must correlate to a stronger Chinese economy. But when the Chinese stock market started dropping from its summit, suddenly the consensus view was that economy must be crashing also. In reality, there is a very low correlation between the Chinese stock market and the Chinese economy. While the global markets largely ignored the relentless appreciation in Chinese stocks earlier in the year, the subsequent drop was very much in focus.

The Chinese government added fuel to these concerns when it surprised the world in late August by devaluing its currency by over 3% in just two days, sending global stock markets lower and prompting discussions around currency wars. The markets interpreted this devaluation as evidence that the Chinese central planners were panicking and desperate. I found it odd that the markets reached this conclusion so quickly. Doesn’t every country want a cheaper currency? Japan has devalued the Yen by about 25% since 2012 and Europe is determined to continue to devalue the Euro. The Canadian dollar is down about 10% YTD (which has certainly helped to shield portfolios from the full impact of the lower stock market values this year). The fact is that the Chinese currency is “pegged” to the U$ and the 20%+ appreciation in the U$ over the last year started to hurt Chinese exports. China’s move to slightly devalue their currency seemed pretty rational to me but markets didn’t see it that way.

The upshot to all of this market turbulence is that the major US stock market indices have finally had a full 10% drawdown satisfying the definition of a “correction” for the first time in almost 4 years which is almost without precedence. We have waited since 2011 to see the broad US market indices decline by at least this much and as painful as it has been, it is nice to get that “monkey off our backs”! Corrections are a normal part of the stock market cycle and they usually occur once every year or so and create firmer footing for further advances by driving out some of the excess and complacency.

One area that has been hit particularly hard lately has been some of the very highly valued “momentum” or “story” stocks that I warned about in my last update. In August, Valeant Pharmaceuticals was the most valuable company in Canada and in spite of this, I didn’t hold a single share in client accounts because I was concerned about valuation and their business model. Well it has fallen hard lately along with most of the biotechnology sector after Hillary Clinton “tweeted” about drug price gouging. Many hedge funds have suffered greatly in this environment. I even read that a large hedge fund had huge positions in biotechnology stocks and had simultaneously “sold short” energy stocks and when biotechnology stocks started dropping, energy stocks started climbing as this massive trade was unwound (by selling the biotech stocks and buying back the energy stocks sold short in order to “flatten positions”). Who would have thought that biotechnology and oil stocks would move in opposite directions because of a hedge fund strategy? That is the way the modern stock market works which I think highlights the need for an investment strategy (as opposed to a trading one).

So now that Valeant is no longer propping up the TSX, the continued weakness in the energy and material space in our market is once again more obvious. And while oil is very likely putting in a bottom in this $40-$50 area, the huge volatility is still keeping value investors on the sidelines. But there is value and the long term players like Suncor have begun to go shopping. I think we will see investing momentum pick up if (when) we see oil break back above $50 next time which will lend our market some much needed strength.

In my last letter I discussed my doubts about how the US Federal Reserve will be able to raise interest rates in this environment. While the markets were expecting the first increase in 9 years after the September meeting, the Fed opted to “stand pat” citing global uncertainty, China concerns, etc. In response, markets continued to act poorly through the month of September believing that that Fed must see the global slowdown that has been feared. The endless debate about when the US will raise interest rates from essentially 0% continues and it is amazing how much time and effort is devoted to that debate. At some point, the Fed will most certainly raise rates once or twice but the idea of going back to “normal” interest rate policy anytime soon is hard to envision. The world is too global now for one central bank to act in complete isolation so until the world can support higher interest rates, we will have to earn more of our returns with growing dividend income.