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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Francisco Torralba--he is a senior economist at Morningstar Investment Management. We're going to get his take on the last few volatile days in the market, what he thinks is driving it, and where he sees valuations at the moment.

Francisco, thanks for joining me.

Francisco Torralba: Thank you for having me, Jeremy.

Glaser: Let's start with what's behind these last couple of days. We've had some big declines and a little bit of a bounceback [earlier today before the market gave up gains]. What do you think is the primary factor? Is it these China worries that are in headlines?

Torralba: First of all, let me say something that there has been an absolute overreaction in the market. There is a whole scale of uncertainty about things. We know with a high degree of certainty that the change in the stock market was a bubble and that it had risen to unjustifiable levels. We sort of know that the Chinese economy is slowing down. We sort of know that their financial system might be in trouble, but with much less certainty than what we know about their stock market. So, what we saw the last couple of trading days was a swing in sentiment because, like you say, it was driven primarily by the crash in the Chinese stock market. But remember, the Chinese stock market was in a bubble. So, it's natural that, after a bubble, there is a crash.

What wasn't justified is that the U.S. stock market or the European stock market or all commodities went down--that was an overreaction. I think that we don't know with more certainty today than we did a month or two ago whether the Chinese economy is doing badly or not. If the crash was based on that, it is was clearly not justified.


Glaser: So, another thing that also crashed--you mentioned commodities. What's driving oil prices lower? Is that also China worries or is there something else going on there?

Torralba: In part. There was a contagion in sentiment across all growth asset classes--like I said, commodities, stocks. But in the oil market, specifically, there is oversupply. There has been a recent report by the International Energy Agency saying that because of Saudi Arabia maintaining their levels of supply, because of increased supply from Iraq, we should expect a continued excess supply, which should depress prices now and for the next few months. Why, in one day, oil prices fell 4% or 5%, again, that was sentiment contagion, not necessarily something that happened yesterday or Friday.

Glaser: Another issue that's on the market's mind is the Federal Reserve and when they will raise rates. Do you see the turmoil over the last couple of days stalling any rate increase or is September still on the table?

Torralba: Well, it certainly doesn't raise the odds of a rate increase. I don't know how much it's going to affect the decision on Sept. 17-18. There's still three weeks until then. The market can go through a lot of swings before then. We have another job-market report in early September that will probably affect the Fed's decision.

It has lowered the odds a little bit. If I were the Fed, my main concern would be the dollar exchange rate, which has continued to increase over the past few weeks. That's going to put deflationary pressure on the U.S. And the second thing I would worry about is the continued decline in commodity prices. Now, they are supposed to look beyond those commodity prices and just focus on core inflation; but it could be that, in the medium term, those lower headline prices translate into lower core inflation as well. So, those are the two things [I would worry about].

Certainly, I never thought it was a done deal that they would raise rates in September, and now it's even less of a done deal. What are the odds? Somewhere around 50% or 60% that they will raise rates. The federal-funds futures market is fully pricing a 25-basis-point raise by December and about a 60% chance of a hike in September.

Glaser: You called all of this market movement an overreaction. Does that mean your view on the global economy hasn't changed? You don't see us on the precipice of a recession or anything like that?

Torralba: Not any more than I thought a month ago or two months ago. With every passing month, with every passing quarter, we probably get a little closer to the end of the business cycle. It's going to be a little different if China is driving or leading the global business cycle. It's going to be different probably from previous business cycles where it was usually the U.S., a spike in oil prices, or a monetary-policy tightening. These are the sorts of things that have usually preceded or coincided with the end of the business cycle. This time seems to be different because it's China leading the global business cycle. But based on the objective data--and coming from China, I don't know what is objective and what is accurate--I don't see us significantly closer to a recession in the short term.

Glaser: Looking at valuations, then, do you think that this has created a buying opportunity? Do stock valuations look better?

Torralba: They certainly look better. I still think that U.S. stocks are moderately overvalued. They're probably not in bubble territory, but they are priced to deliver very low returns over the long term. There's been a correction in the credit market in the U.S., so credit spreads are not as ridiculously low as they were a few quarters ago. I think, again, they are not grossly overpriced or underpriced. And with U.S. bonds, it seems to me that long-term interest rates are awfully low. So, there will be very low returns there, too. So, in the U.S., it's hard to see good buying opportunities.

Glaser: Thanks for your take on what's going on in the market today.

Torralba: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

* Disclosure
Morningstar's Investment Management group includes Morningstar Associates, LLC, Ibbotson Associates, Inc., and Morningstar Investment Services, Inc., all registered investment advisors and wholly owned subsidiaries of Morningstar, Inc. All investment advisory services described herein are provided by one or more of the U.S. registered investment advisor subsidiaries. The Morningstar name and logo are registered marks of Morningstar, Inc.

The information, data, analyses, and opinions presented herein do not constitute investment advice; are provided as of the date written and solely for informational purposes only and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Past performance is not indicative and not a guarantee of future results.

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