Financially speaking that wasn't the best way to start 2016. The markets had the worst first week of the year in history, down 5-7% depending upon the index you happened to be referencing. This is after a 2015 which saw almost all the major indexes with returns of close to zero. So what the heck is going on?

  

This downturn is not coming on the heels of the downturn we saw in the late summer - it's part of the same downturn. In August the U.S. and major developed market indexes had a pretty substantial sell-off triggered by market problems and currency devaluation in China. What we've seen since the first of the year is just a continuation of that cause. As a controlled economy at least in theory, the Chinese government can come in and gloss over some of their market's problems. That's what happened after the severe sell-offs in August, which didn't allow that market to "clear" or find its bottom. Once the New Year was rung in and some of that governmental support was pulled, the sell-offs began again - this time Chinese governmental interference unintentionally served to deepen the reaction in the rest of the world rather than quell it. Let me step back a minute before I explain China in more detail. What is happening in the U.S. and major European markets is related more to the liquidity of their markets than to the underlying value of the stocks those markets represent. There are two major economic issues hitting U.S. equity prices at the same time, the mess in China and the price of oil. In both cases there are giant pools of money in the world that are being squeezed by these twin, and related, issues. These pools; sovereign wealth funds of oil producing nations like Russia and Saudi Arabia, banks in China and other Asian nations, very wealthy individuals connected to both areas, were put in place to hedge those entities against the volatility of the countries or areas they are from: Hedge the Saudi's against a drop in oil prices, hedge a rich Chinese business man against a crisis in the Chinese economy, for example. Now those two things are happening, so these funds / banks / individuals are selling the assets that they can easily sell to create the cash they need to run their countries / support their reserves / live their lifestyle. Those assets are the stocks of multi-national corporations trading on U.S. and major European and Asian stock markets. Then of course when you get selloffs the general panicky investors all hop on board and you get the first two weeks of 2016.

  

For more specificity, the Chinese government installed circuit breakers on their markets, much like we have here in the U.S. where if the market sells off a certain amount during the day there are trading stoppages and then if the sell-off continues the market is eventually closed for the remainder of that session. In the United States (The major European exchanges are almost identical) the first 15 minute pause doesn't even kick in until the market has dropped 7%, and to close the market for the day it would have to lose a full 20%; and that's in a developed market where the volatility is much lower than it can be in an emerging market exchange, like China. The Chinese government set their daily limit at only 7% and for several days in a row to start the year (until the Chinese government removed the circuit breaker) their stock market hit that level in a few minutes and then closed. For the first three days of 2015 the Chinese exchange was only open for a total of about an hour. If you are a Chinese investor or bank or someone who has lots of holdings in China you suddenly can't be sure you can sell your stocks if you should need cash - even if you intent to hold them for the long term. So what do you do? You sell your U.S. or European holdings to create cash while you wait for the Chinese market to straighten itself out. Similarly these Sovereign Wealth Funds (essentially investment portfolios owned by a country instead of a person) are finding themselves in the same boat. The largest of these funds happen to belong to countries that rely on oil and other commodity revenue for the majority of their national income, countries like the aforementioned Russia and Saudi Arabia, but also Norway and Nigeria. These funds were created to give these countries another source of income should oil prices crater, and that's just what has happened. Many of the investments these funds make are long-term and somewhat illiquid - they can't just liquidate a fleet of cargo ships for example. But they can liquidate some stocks to create some cash just in case. Furthermore, since they don't want to earn nothing on that money they stick it in U.S. treasuries driving down interest rates even as the Fed is raising them.

  

As for The Fed, they are really caught in a conundrum. They should have started raising rates in August or September. That way we would have had two or three increases going into the first of this year with these tremendous deflationary pressures in the world economy all converging at once. The Fed then could have at the very least stopped raising rates until we have a better idea of the depth of this commodity and equity sell-off. As it stands, since the Fed only raised rates at one meeting, if they pause now the unintended consequences of pausing could have a worse impact than the actual economic consequences of raising rates another ¼ - ½ point. What I mean by that is the U.S. economy is, as of today, still doing pretty well. GDP growth is positive, employment growth is better than expected, and we even got wage increases of about 2.5% - which while low by the standards of other recoveries it comes with inflation below 1%. The Fed raised rates based on the ability of the U.S. economy to bear those increases and to keep inflation from spiking up - if the Fed makes one increase in rates and then reverses course doesn't that mean they were wrong about the U.S. economy? Sometimes these things can become self-fulfilling prophecies whereby the Fed actions indicating the U.S. economy isn't as good as we think spooks investors and lenders into investing less and lending less and thus the U.S. economy actually slows down. Raising interest rates into this environment is probably not a smart move - but the impact of another couple ¼ percent increases may very well be less than the impact of announcing that the economy is weak.

I'm not here to make predictions about the year ahead. I have no idea what's going to happen. It's possible the rest of the world drags the U.S. into a recession, it's possible this next couple weeks are the nadir of China and Commodity prices and everything rallies going into the spring. So what do you do? As I have said a million times, your assets should be invested for when and how you're going to use them not for what the market is going to do in the short-term since that's not possible to know. However, there are a few things you can do while energy costs, interest rates and equity prices are still low to set yourself up for a better future. Use the extra money you should have each month by paying substantially less for gasoline and home heating costs to pay down debt, refinance whatever you can (mortgage, consolidate credit cards) or make additional contributions to your investments. Yes doing these things doesn't give you extra money in your pocket you can spend now; but it may give you lower expenses or extra money every month for the rest of your life in the future. If you're living off your investment assets, maybe you can cut back on what you're taking each month. Think the current low gas prices don't add up to much? Take an average couple with two cars driving 12,000 miles per year each - based on an average 20 mpg at current gas prices you're saving $170 month from what you were paying just 15 months ago. Add in oil or natural gas prices for home heating and you could easily be saving $250 / Mo. this winter. Struggling to pay off that credit card? Can't find the extra money to fund your 401K? Well there it is.   Take advantage of it while you can. Also with interest rates dropping back down again, this may be the last chance to finally refinance your mortgage or consolidate your other credit at a low fixed rate. Outside factors can fight against the Fed when it goes up by a quarter or half a percent but eventually the Federal Reserve will win. In conclusion for this month - don't look at this poor opening to the year in the markets as a problem, rather as an opportunity to square things away in your financial life so when the markets turn around - and oil prices and interest rates go along with them - you're better prepared.