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Recent Share Market Turbulance

Posted: August 25, 2015 at 9:38 am   /   by   /   comments (0)

Over the last few days you may have heard about a downturn in the share market. Indeed the fall in global share markets and the Australian share market have been significant. It is rare for shares to fall more than 3% in a single day and unfortunately that is what we saw yesterday on the Australian stock market and overnight in the US.
The media love these events. They happily ignore the markets when times are good, but whip into a frenzy when times are bad. This is partly because they know fear sells. But it is also due to the nature of share market cycles, with falls in the share market being more extreme than the rises. There is an old saying in the financial community ‘shares go up the stairs and down the elevator’. To put it another way, share market rises are normally moderate and controlled, but falls can be sudden and steep. The reason for this is relatively simple. When people buy shares, it is normally a careful, considered decision, based on the circumstances of the individual. Selling on the other hand can be a knee jerk reaction in response to negative news. When a lot of people all choose to sell on the same day, a sharp fall ensues.

Where to from here?
The big question most people are asking is ‘where is the share market headed over the next week or the next year?’. Unfortunately no-one can answer this without a crystal ball. There are always journalists or fund managers looking to make a name for themselves by predicting the next share market crash. The Herald-Sun’s Terry McCrann has made some bold predictions this time around. His comments have been picked up by the press and he was a special guest on 3AW this morning. The general rule of thumb, is that whoever has the darkest, most negative opinion, they are the one’s who are interviewed on TV and radio and reported in the press. But it is a dangerous game. Alan Kohler (ABC business news reader) famously announced he was selling his shares due to the risk of ‘another major panic sell-off on the market’ in late 2011 [1]. What followed, was exactly the opposite – a very strong period of positive returns. Which goes to show, when it comes to the share market, you should be very careful about making short-term predictions. As for Terry McCrann, who this morning predicted a $60B fall (ie. 4% loss) for the Australian share market today [2], well, Australian shares finished up (that’s right, UP) by almost 2.5% today. That’s a difference of 6.5%!
A clever journalist for Bloomberg (a major American financial publication) recently looked at the history of major market movements since 1980 so see how accurately recent falls predicted future market performance [3]. The results are interesting. When the US market fell by more than 5% in a week, the returns over the following week and the next 12 months were, on average, positive. In fact shares were up over the next week more than 60% of the time, and over the following 12 months, shares were in positive territory more than 70% of the time. So as you can see, predicting a downturn is very risky and those who come out of the woodwork with negative predictions at times like this are more than likely wrong. Apart from the terrible prediction from Terry McCrann this morning, he did have some sage advice during his interview with Ross Stevenson this morning:

Ross: So if you’re in the share market what is it, put on the hard hat and ride it out?
Terry: Well that’s usually the advice, obviously because you don’t want to be the guy that cracks and sells out at the lowest prices [2]

So what sparked the recent share market falls?
There are lots of opinions floating around at the moment, here are the top 4:

China’s economy
In recent months, there are clear signs that the Chinese Economy is slowing. In fact, last week, the Chinese Government took action to devalue their currency, the Yuan, to help support their economy. This was a surprise, as there was a general expectation that China was moving towards a market based system, where financial markets dictate currency movements rather than the Government. However those who have been following the Chinese economy would know the Chinese Government have been deliberately trying to slow down the Chinese economy for a number of years now. The extraordinary GDP growth of 10% pa, which we saw just a few years ago [4] was never sustainable. However when Governments intervene to slow things down, there is always a risk that they may go too far. Combined with other issues, which I won’t go into here, there do appear to be some significant challenges facing China at the moment. But the good news, is that the Chinese Government stands ready to inject stimulus into the economy if necessary with an extraordinary $3 Trillion US dollars of reserves at their disposal. The lowering of the Yuan may be just be the first sign of a package of reforms which could emerge to help stabilise their economy.

Chinese share market
It is rather silly for the media to suggest the China’s share market has caused this sell-off. Yes, the Chinese share market (ie. Shanghai Stock Exchange) has crashed in recent weeks, down more than 35% from it’ peak. But the commentators sometimes forget to mention Chinese shares had an extraordinary rise of more than 150% in the previous 12 months. Putting those breathtaking figures aside, the Chinese share market is largely irrelevant to the rest of the world. Most people who buy Chinese shares are Chinese citizens, and they are not allowed to buy shares from anywhere else. For those of us outside China, it is very hard to buy into their market. Even a specifically Chinese focussed managed fund which I am familiar with, has only 20% of the portfolio invested in stocks listed on the Shanghai Stock Exchange [5]. The balance is mostly invested in the Hong Kong share market, which hasn’t risen or fallen anywhere near the level of the Shanghai Stock Exchange. My personal opinion, is that those journalists who suggest the Chinese share market is to blame for the recent falls around the world are simply lazy and haven’t done their homework.

US Interest Rates
It has been almost 6.5 years now since the depths of the Global Financial Crisis, caused by the US. While the US economy isn’t perfect, it has undergone a great deal of healing and most indicators are very positive. The record low interest rates, which are still in place, are looking very outdated and the US Federal Reserve has indicated for some time they will start to increase interest rates very soon. There has been a lot of speculation about when they will start, with September being the consensus view for some time. There is a possibility that recent volatility might delay the decision. But that aside, the speculation is certainly considered to be one of the main reasons why markets are having a poor time at the moment. With around half of the world’s share market being US listed shares, and low interest rates having a positive impact on economic growth, it is understandable that investors are wondering how profits will hold up when interest rates start increasing. However one should always remember, Janet Yellen (the head of the US Federal Reserve) and her counterparts, will also be acutely aware of the possible negative impact and they will carefully monitor the situation in an effort to maintain growth as they raise interest rates. Any sign that growth is faltering is likely to be met with a pause, or even a reversal of interest rate rises.

Commodity Prices
Over the last 12 months, key commodities such as iron ore, coal and oil, have all fallen sharply. This certainly affects those directly involved in mining or servicing the mining industry, and for Australia, we are impacted more than most countries. However lower commodity prices, particularly oil, are a significant positive for world growth. Those countries which are growing strongly, such as China and the emerging markets, will undoubtedly benefit from the lower prices. While the sudden fall of these commodities is a shock, and may be contributing to the current volatility, the longer term impact of lower commodity prices is a positive.

The real reason for recent falls
In my opinion, the truth behind recent falls on world share markets is much more simple. The fact is, share markets around the world have performed very well over the last few years. The US market in particular, has seen an almost uninterrupted bull market since March 2009. After such a strong run, most market watchers start to think about the next downturn. Share market falls are a natural part of the ebbs and flows that characterise the share market. So an expectation has started to build for some time now, that a downturn might be around the corner. I have seen this expectation expressed in many seminars, newsletters, articles and conversations I have had over the last 12 months with fund managers, economists and fellow financial planners. I believe the growing expectation that the next market fall could be around the corner is the key driver behind the current falls. With the other factors mentioned, simply a trigger or an excuse for some investors, particularly those who have short-term views, to sell off their shares. In essence, the expectation that share markets might soon fall, becomes a self-fulfilling prophecy. Fortunately the same thing also happens in reverse, following a downturn. With a general expectation that prices will recover eventually leading to a lift in share prices.
While the recent falls can be frustrating and disconcerting, it is important to remember that shares are a long term investment. Holding through these periods and continuing to focus on your longer term goals is important during times like this. The good news is that the wider global economy is in pretty good shape at the moment. China (and Asia generally), while the growth is slowing, they are still growing at a very respectable rate (if that makes sense?), the US economy is performing very well, and even Europe, which has been a cause for concern in recent times, seems to be well past the worst and on a much more stable footing. All of the commentary I have been reading in recent days, from highly respected economists and fund managers, has been universal in the view that the medium to long term economic picture looks good. Having said that, there is still a lot of nervousness around particularly regarding the possibility of further short-term falls in the Australian and global share markets.

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[1]Matt Ryan, Forager, ‘Bad Year, Stellar Results’ (viewed on the web, 25th August 2015)
[2]Terry McCrann, 3AW, ‘Terry McCrann talks to 3AW about the current situation with China, our stock market and the Australian dollar’, 25th August 2015
[3] Julie Verhage, Bloomberg, ‘Here’s What Usually Happens to Markets After the S&P 500 Drops 5 Percent in a Week’, 24th August 2015 (viewed on the web, 25th August 2015)
[4] The World Bank, ‘GDP growth (annual %)’, viewed on the web, 25th August 2015
[5] Derek Paas , Premium China Funds Management, ‘Market/Fund Update – Premium China Funds’, Email to Advisers – 10th July 2015

Disclaimer – The information contained above is general advice only and current as at 25th August 2015. It has been prepared without taking into account the investment objectives, financial situation or needs of any particular person. Therefore before acting on any information you should consider its appropriateness, having regard to your personal objectives, financial situation and needs. You should also obtain a copy of the relevant Product Disclosure Statement before investing in any product. This information is given in good faith and has been derived from sources believed to be accurate at its issue date. However, it should not be considered a comprehensive statement on any matter nor relied upon as such.

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