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Another market stumble. What happens now?

October 12, 2018

John Carran

Written by John Carran

Senior Economist at Kiwi Wealth
John's responsibilities include monitoring economies and markets to identify both investment opportunities and risks across asset classes, regions, sectors and industries.

Kiwi Wealth Senior Economist John Carran shares his views on recent market developments.

Another market stumble

Global share markets have sold off sharply since Wednesday night. The US market has so far been one of the hardest hit and is down 5.3% over the past two days. Many Asian markets, including New Zealand, sold off 3-4% yesterday and may be in for a rough ride again today.

Markets and parts of market that have generally made the most gains since the beginning of the year, such as US technology and communication and some cyclical shares, have fallen the most since Wednesday. This is because valuations are generally higher and prices are more susceptible to rising interest rates.

Bonds provided little solace to investors on Wednesday as interest rates hardly changed, despite the aversion to riskier investments. There was some rally in this investment class on Thursday night as interest rates eased a little with the release of a slightly weaker-than-expected US September CPI number.

Prediction of higher interest rates sparked the drop

Although there was no specific event that sparked the Wednesday sell-off, it is undoubtedly a delayed reaction to developments over the past week that have significantly raised peoples’ predictions of future interest rates.

These developments include an indication from US Federal Reserve Chair, Jerome Powell, that interest rates may rise faster than previous thought, and the ramping up of trade tensions between the US and China, which is likely to raise company costs.

Why are interest rates rising?

In my view, interest rates are mainly rising for relatively benign reasons. That is, global growth is on a solid footing and inflation is only gradually accelerating. Thus, it is prudent for central banks to increase their vigilance of inflation, without being over-reactive.

Despite Mr Powell’s comments last week, there is no sign the Fed or other central banks are jumping the gun in tightening their policies. In fact, all the large central banks have been clear they will only slowly pull back from accommodative policies, preferring a little extra inflation than stomping on economic growth too soon.

For these reasons, reasonable support for shares remains.

Sell-offs may continue, but shares have support

However, there are risks that the sell-off over the past two days will be extended.

Investors are wary that the decade-long bull run in shares may soon come to an end. Investors may be looking past what is happening in the near-term to the possibility of a recession in the US economy, perhaps starting next year.

In my view, at this stage there is little sign that either of these things will happen, but any new information that supports the view of a weaker economy may be an excuse to sell.

Recent moves in context of past good performance

If market declines are extended this month it’s possible valuations in most Kiwi Wealth KiwiSaver Scheme investment funds will be lower at the end of October, although there is still a way to go in the month yet.

This should be seen in the context of very strong returns in recent years, particularly for funds with high exposures to global shares.

For instance, the return on the Kiwi Wealth KiwiSaver Scheme Growth Investment Fund after fees and taxes was 12.8% in the 12 months to end of September and has averaged 10.6% after fees and taxes over the past five years.

Market swings a feature of shares, but superior returns in the longer term

We’ve been warning for some time that market swings may become larger this year, returning to a more normal pattern after several years of extraordinary stability.

Although it can be uncomfortable at times, the large swings that periodically occur in share markets have been accompanied by superior returns, for this type of investment, over the longer-run.

This article reflects the personal views of the author at the date shown above. The information provided, or any opinions expressed in this article, are of a general nature only.

Tags: Economy

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