Market Correction - August 2015

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Global share markets fall despite sound fundamentals

All major share markets have been sold down heavily over recent days. The correction on equity markets has also been accompanied by ongoing falls in the price of commodities and emerging market currencies. Since the beginning of August, Australian shares are down 12%, with losses of 10% to 12% recorded across the United States, Europe and Japan. Chinese shares have declined 14% since the start of the month.

What has caused the market correction?

Similar to 2011 when the market fell by approximately 22% and then recovered over the following 18 months, there appears to have been little change in underlying market fundamentals, with the economic backdrop remaining relatively stable and supportive of modest company earnings growth. Rather, the sell-off seems to have been largely sentiment driven. In 2011 it was concerns about Greece and US debt ceiling, now it is concern about the outlook for China.

AMP Capital Chief Economist Dr. Shane Oliver highlights that markets are currently "full of emotion" and characterized by nervousness. Underpinning the market's nervousness seems to be increasing concern over the outlook for Chinese economic growth, ongoing weakness in commodity prices and fears that the combination of falling commodity prices and weaker Chinese growth will be particularly problematic for emerging markets. As a result, funds have flowed out of emerging markets causing sharp falls in many emerging economy currencies.

Is it a correction or something worse?

Knowing when a fall of the magnitude experienced in recent days occurs is difficult, sharp declines in share markets of up to 20% are not unusual and do not imply there will be an extended period of weakness. In fact, corrections can be a healthy characteristic of "bull" markets, allowing investors to reassess valuations before a rising trend resumes.

As mentioned in the past, trying to time the market has its own dangers and is rarely timed right. Holding funds in cash during a low interest rate environment does not compare to a quality parcel of Australian shares that can deliver an income (yield) between 4.5 to 6.5% per annum, assuming one has a long term outlook and can “comfortably” ignore the short to medium term capital volatility.  

Dr. Oliver believes that the longer term trend for shares remains upwards, stating that: "Our view remains that the cyclical bull market in shares likely has further to go. Put simply shares are not seeing the sort of conditions that normally precede a new cyclical bear market: shares are not unambiguously overvalued; they are not over loved by investors; uneven and below trend growth is extending the economic expansion cycle; and monetary conditions are likely to remain easy for a while yet."

Previous market falls that have preceded more extended market downturns tend to have been associated with financial system dysfunction, excessive overvaluation or imminent economic recession. None of these factors appear to be in place today. In particular, the global economy remains on a modest growth path with low
inflation and accommodative policy support creating an environment conducive to company profit growth. Locally, the latest profit reporting for the period ending June 30th, confirmed a steady rise in the profitability of Australian non-mining companies of around 7% from the previous year.

Although share market fundamentals may remain sound, share market valuations can move away from fundamentals for extended periods. As such, the latest sell-off suggests that caution is required by investors, particularly around emerging markets. However, with little change in the outlook for underlying company profitability, investors should maintain longer term strategies and asset allocations. In fact, for investors with underweight positions to equities, the current sell-off may represent an opportunity to enter the market.

Please do not hesitate to contact us should you wish to discuss recent market events or any aspect of your investment strategy.

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