Current correction in markets
Back in February this year we had a share market decline of 10% in the US and 6% in Australia. Over the following month things improved and the market continued to rise again. I wrote at the time that the decline in the market was mainly due to concerns about rising rates in the US and the rapid growth in their market. We expected things to improve and by September the US hit new records and the Australian market hit a ten year high!
The current pullback in shares has been triggered by a range of things however the predominant issues are the same – investors have again started to worry that the very strong US economy will push the Fed into tightening a lot more (i.e. raising rates) and that this will cause a further sharp rise in bond yields which will threaten growth and share market valuations.
There are always other contributing factors, like the China conflict, fears about slowing economic growth, vulnerability of technology shares in the US, tensions in the Eurozone, nervousness about the Mueller inquiry, rising oil prices, threats to growth in emerging markets, and the month of October (yes, October is known for its share market volatility). There are always many factors as markets constantly react to a multitude of macro and geopolitical issues.
At the time of writing, the current decline in the Australian market has been just under 8% for October. Shares may still have more downside however our view is this decline is another correction and periodic corrections of 5-15% are healthy and normal. For example, the Australian share market had a 10% pullback in 2012, an 11% fall in 2013, an 8% fall in 2014, a 20% fall between April 2015 and February 2016 and a 7% fall earlier this year.
So what is a ‘correction’? What stipulates an ‘official correction’ and when does it change from a correction, to a ‘bear market’? Well, these terms are very subjective and as there is no government agency or ASX department responsible for certifying such terms, there is always the opportunity for them to be used to confuse and create unnecessary fear. According to Investopdedia, a correction is generally defined as a ten percent or greater decline in the price of a security from its most recent peak, hence the media announcing the US had an ‘official correction’ last week - however technically there is no such thing as an ‘official correction’. Therefore, in February this year when it was announced we had a ‘correction’ in the Australia market maybe we didn’t as the decline was only 6%. How we love labels! Seemingly, from what I can gather, it is generally accepted that a correction is a drop in the share market of 10%, while a bear market is more than 20% and is a result of a longer more sustained decline over a period of two months or more – similar to the market in April 2015 to February 2016. Saying this, many (including myself) use the term ‘correction’ as any rapid readjustment and recalibration of assets that may have become unsustainably high.
One of the main drivers of whether we see a correction or even a mild bear market as opposed to a major bear market (like that seen in the global financial crisis (GFC)) is whether we see a recession or not – most importantly in the US. Our assessment remains that US/global recession is not imminent as we still have high levels of business and consumer confidence globally, while US monetary conditions have tightened we are a while away from the sort of monetary tightening that leads into recession. There are also not the excesses in terms of debt growth, overinvestment, capacity constraints and inflation that normally precede a recession globally or in Australia.
It is worth keeping in mind that corrections are normal and the percentage drop can be significant for many investment portfolios. The timing and magnitude of a correction is hard to determine but they are generally short lived.
Market volatility is here to stay and there are some risks ahead that will continue to remind us over the course of the next 12 months. It’s worth stating, that regardless of what’s happening here or abroad, we continue to closely monitor the markets, diversify portfolios and invest in growth as well as income producing assets.
During these times it is worth remembering to turn down the ‘noise’ and remember that share market corrections are healthy as they help limit the build-up in complacency and excessive risk taking.