THE AUSTRALIAN SHARE MARKET ENTERS A TECHNICAL “CORRECTION” – BUT WHY?
By Paul Nicol
At the time of writing (Monday morning 29th October) the Australian S&P ASX 200 has retracted to 5,665 points, wiping out all of the gains for 2018, and falling from its peak of 6,352 points on the 29th of August, representing a fall of -10.9%. A technical correction in the share market is a fall greater than 10%. The last correction in the Australian share market was in February 2016, highlighting the lack of significant volatility in markets over the last few years.
The sentiment towards share markets has certainly turned bearish for a number of reasons including:
- Rising U.S. interest rates
- Fears that the US-China trade war is likely to become prolonged and nasty
- Increasing concerns about global growth with weaker economic indicators recently coming out of China and Europe increasing fears that global activity is slowing
- Cooling sentiment around the digital giants or FAANGs (Facebook, Apple, Amazon, Netflix and Google) with recent earnings updates from (Google parent-company) Alphabet and Amazon disappointing the market
A common fear in times in which the market is experiencing (an apparent) correction is to assume that it reflects the state of the underlying economy. But that does not appear to be the case on this occasion.
The primary driver of the recent correction, as it almost always is, is the decision making of the US Federal Reserve. Stronger than expected growth figures out of the U.S. support the need for higher interest rates with the U.S. Federal Reserve re-affirming their path to a normalisation of interest rates via increases to the official cash rate. In addition to increased interest rates, inflationary pressures are rising in the U.S. as wage inflation, higher input costs and tariffs place pressure on corporate earnings. As corporate earnings growth slows, it removes much of the solid underpinning that has helped propel equity markets higher.
Investors with good memories are still bearing the scars of the GFC and the initial worry of a pending financial calamity leading to economic calamity still looms large. But on this occasion the U.S. economy is booming and as confirmed by the recent earnings seasons in both the U.S. and Australia, stock fundamentals look solid, with aggregate earnings growth in Australia last financial year of 8 per cent, and another 7 per cent expected for this financial year. It does not seem on the cusp of a dramatic deterioration in company fundamentals, but there is a prospect company earnings could slow.
It’s always impossible to predict whether market volatility is indeed something indicative of underlying problems. Without doubt, far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves. As the old adage goes, it is time in the market rather than timing the market that works. We suspect the current correction is unlikely to turn into a technical bear market (a fall greater than 20%) and the October jitters will not get significantly worse.
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