Thoughts on the markets
With wild swings in world share markets dominating the news in recent days, I thought it would be useful to update you on what is driving these moves and perhaps allay some fears that we are on the edge of another GFC-type situation.
After a negative lead from the US and European markets on the weekend Australia followed suit with dramatic falls on Monday with the S&P/ASX 200 down 4.1%, revisiting the important 5000 points mark. This was followed up by large falls in US, UK and European markets, all down between 4% to 5% in the next night’s session.
Banks and resources have led the falls in Australia. Why? It appears the world is coming to terms with the idea of a lower growth China and what this means for businesses that have relied on strong Chinese growth and for commodities. China has been the largest marginal buyer of most commodities since 2008 and many of these are now in oversupply and facing falling demand, so they are being repriced in the process and also being hurt by a resurgent US Dollar.
Specifically, other triggers for the falls appear to have been the recent Chinese share correction (after a large run-up in the order of 125% over the 12 months to June 2015) and the moves last week by the Chinese authorities to devalue the Yuan, not once but three times – which was seen as strong evidence that the scale of the slowdown in China is widening. The growing nervousness was exacerbated by weak manufacturing numbers out of China last week, which have declined further than expected. Balancing this is the US recovery, which is real and solid, similar with the UK, hence this slide looks to be driven by fear rather than fundamentals or any widespread systemic crisis (unlike 2008/09).
Unfortunately for Australia, no other developed world economy was more leveraged to China on the way up and the same applies on the way down. The resources sector is continuing to deflate on the back of collapsing commodity prices, which had already declined a long way from their peak of recent years. The Australian property bubble and its associated debt build up (relative to GDP) both seem to be peaking and this is seeing investors dump the banks. It appears earnings for big banks have plateaued, from their recent results, with bad debts at all-time lows and likely to pick up from here and combined with massive capital raisings being conducted at present by the banks mean it is not the best of times to be a bank shareholder. CBA and others may be forced to either reprice or pull their current capital raisings in this climate, with share prices close to the rights issue prices, rendering them unattractive.
What are the bright spots in all this? Any US rate rise will be pushed out for a while longer (even talk of QE4 in some quarters!) cheaper energy and a weaker AUD, which will buffer your unhedged global assets, and is generally positive for much of the Australian economy (exporters, tourism, farmers etc).
Remember diversification is your friend at times like this. Equity markets are liquid so the shares that trade on them can be repriced very quickly, unlike illiquid markets such as property, which usually take years to reprice to reflect the changed world. Following the large declines in commodity prices, resource companies now make up only about 14% of the value of the ASX, having peaked at around 30% in 2011, thus reducing their importance as a driver of share market returns for Australian investors. This should help limit further falls in the ASX benchmark. As with previous downturns, quality companies should be the first to bounce back as bargain-hunters appear and high quality companies with attractive and sustainable yields will be among the first to recover. Yields on quality shares are now even more attractive against cash rates and with a growing prospect of further interest rate cuts in Australia, such stocks should find support. We are cautiously confident that your portfolio will get through this and go on to do well for you into the future.
We always take care to ensure your portfolio is properly diversified across asset classes and invested with experienced and proven fund managers, who have navigated such market conditions many times before and know how to take advantage of buying opportunities that appear at such times. Please feel free to call if you wish to discuss further or have any specific questions regarding your portfolio.