20 November 2018


Recently sharemarkets lost about 10 per cent of their value.

This put them into “correction territory”, and has led to widespread fears a bear market is developing.

It’s early days yet, but my guess is this turbulence in share prices will turn out to be a fairly mild fake crisis.

Relative to other fake crises experienced in sharemarkets — particularly those of 1994 and early 2016 — this one has fewer things to worry about. Here’s why:

The US economy has strengthened noticeably in recent months, with little evidence of either a marked slowing or an early recession.

US company earnings in the June quarter were 25 per cent higher than in the June quarter of 2017, and analysts had been forecasting (correctly as things turned out) that US earnings in the September quarter would be more than 20 per cent above those in a corresponding quarter a year ago.

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Though largely one-off (and related to the Trump cut in company taxes), the strong rise in profits had dampened earlier concerns US share valuations were stretched to breaking point.

In July and August, Australian companies reported, on average, what many people saw as “solid” financial results.

China has seen some moderation in growth, but also an easing in monetary policy. 

In the US and Australia, bond yields didn’t fall much as shares were dumped. And Australia’s yield curve for government bonds continued to trade comfortably below the US yield curve throughout the bad days in sharemarkets. 

Prices for our bulk commodities, particularly iron ore, remained well-supported in October and early November.

The Australian dollar, which often dives when global sharemarkets plunge, held fairly steady. (It had weakened a lot in September, particularly against the buoyant US dollar, when foreign exchange markets believed the Aussie dollar would suffer “contagion” from the problems in Turkey, Argentina and South Africa.).

Sentiment in sharemarkets turned extremely gloomy on the day when “$52 billion was wiped from the value of Australian shares”. But some highly regarded share investors and strategists kept their cool and have been looking for opportunities.

I was particularly impressed with the report Frank Macindoe, an adviser and partner at Koda Capital, circulated during the panic. He pointed out that we should never be confident in short-term market predictions because in that period the sharemarket is largely driven by sentiment and herd-like behaviour; but investors always need to recognise there are many more corrections to share prices than there are bear markets in shares.

He made the point that for every bear market (falls of more than 20 per cent) experienced in US shares since 1974, there have been more than four corrections (falls of 10 per cent). That is, more than 80 per cent of equity market corrections in the US since 1974 have not turned into bear markets.

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“It is worth remembering,” he adds, “that a real bear market is almost always the result of a recession, and there are few immediate signs of that, though US corporate debt burdens are a concern.

“By contrast, Australian corporates may never have had lower debt levels.

‘‘Some growth stocks (including CSL, Cochlear, REA and Seek) had earlier taken off (especially after reporting good results) and now we are simply seeing their prices come back to trend.

‘‘Some stocks that have good long-term businesses have come back a long way and I would now be happy to buy.”

Frank’s words brought to my mind the observation Paul ­Samuelson, a famous US economist, made in 1966: “The US sharemarket has predicted nine of the last five recessions.” Additionally, the recent crash in share prices has reinforced the view of many investors that sharemarket returns are unacceptably volatile.

However, for patient investors, volatility in share prices creates a useful reward for investors.

After all, it’s the compensation for volatility that has raised the long-term return from Australian shares to the attractive rate (pre-tax) of 10 per cent a year and of 7 per cent in after-inflation terms.

Don Stammer is an adviser to Altius Asset Management and Stanford Brown Financial Advisers. The views expressed are his alone.

Read more at theaustralian.com.au