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Recent market declines

February 7, 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.


Global share markets went into a tailspin Monday night, following on from steep declines on Friday night. The S&P500 fell 4.1% on Monday night, which is its largest one-day fall since August 2011. This followed its 2.1% decline on Friday night. In Asian trading on Tuesday, sell-offs were even steeper, around 4-5% in some cases. European share markets also fell substantially, with major markets in that region down substantially on Monday and Tuesday nights.

US share markets bounced back on Tuesday night, with the S&P500 closing up 1.7% for the day. It’s too soon to tell whether sentiment has been stabilised. It’s possible that volatility could persist for a while yet.

Risk-off sentiment started last week as investors priced in higher inflation and interest rates in the wake of the strong US jobs report released on Friday, which showed a faster than expected acceleration in wage growth. As the day progressed, it appeared that automatic quantitative trading exaggerated the declines in the US, with major indices in that country plummeting around 6% at one stage, before recovering to a degree.

Initially, share market sell-offs last week were accompanied by rising interest rates on longer-maturity bonds and declines in bond prices. Subsequently, interest rates have eased back a bit, with the rate on a US 10-year government bond falling to 2.78% from its recent peak of 2.87%. Nevertheless, bonds haven’t provided the safe port in the storm that might be expected given the magnitude of the share declines. This reflects the current source of market concern – the prospects of higher inflation and faster than previously expected central bank interest rate hikes, which are negatives for both shares and bonds.

We have been warning for some time that elevated valuations make share prices vulnerable to corrections on bad news. This has come to pass in recent days. Changes in sentiment are very hard to predict. It is possible that markets may continue to decline in coming days or weeks. Any declines, however, need to be seen in the context of stellar share market gains over the past several years. Over the past two years, global shares have gained over 50%. What’s more, market gains have come with very little volatility, which is unusual in an historical context. The spell had to be broken at some stage.

Fundamentally, there still appears to be good support for shares. The global economy is gaining momentum. Last week, a survey of the Eurozone economy in January showed activity in the region at a 12-year high. Activity in the US and Japan robust and broad-based. In most major markets outside the US earnings have been revised up. The balance sheets of companies and banks are in generally good shape and there are few signs of credit stresses.

Although there are signs that inflation is ticking up in the US, this is off a historically low base. In other large economies, such as Europe and Japan, capacity pressures are a lot less and there is very little sign of inflation breaking out. Interest rates are still a long way below historical averages, even with recent rises. Central banks aren’t about to suddenly pull the rug out from under markets – they will more likely tolerate slightly higher-than-target inflation rather than be trigger-happy on interest rate rises.

It’s possible that recent market falls will result in lower valuations in most Kiwi Wealth KiwiSaver Scheme investment funds for February, although there is still a way to go in the month. 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 18% last year, and accumulatively the Fund is up over 80% after fees and taxes over the past five years.

Current volatility is not a new phenomenon. 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.

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The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.

Photo by Markus Spiske on Unsplash 

Tags: KiwiSaver, Economy, Performance/returns

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