It’s very likely that you’re going to hear a bit of noise about the stock market over the coming days. The US has just had its largest single day drop in history off the back of a large drop on Friday. It’s now significantly affected Australia too.
Yesterday, I attended a Chief Economists forum. The panel consisted of six of the Chief Economists for several very large investment groups. As you can imagine, it wasn’t my most entertaining morning of the last few weeks, but it was very relevant.
The view in the room was that the global economy is actually going quite well. We have some good signs right across the world and there’s economic growth coming in the year ahead.
However, increased growth doesn’t necessarily mean increased share prices.
So, what does it mean?
Share values are incredibly complex. A few key reasons why shares have done really well recently include:
- Low interest rates – and delays before increasing them
- Central banks injecting HUGE amounts of money into economies
- Favourable tax changes in the US
- Low bond yields
It might seem counter-intuitive, but one of the key reasons for the stock market drops in the US is actually to do with all of the favourable data coming out of the country. As these figures are positive, it’s likely to mean that the US central bank (the Federal Reserve) can focus on decreasing government debt and increasing interest rates.
Because the data is so good, this could potentially happen faster than people were predicting. For instance, the market seems to think that the Federal Reserve will increase rates four times this year, instead of the three that they expected only a short time ago. This means that there would be higher cost of cash – and less of it – to go into share markets.
In turn, this makes investment managers take a second look at their methods and assumptions on how they value shares. In this instance, downwards. Because the market is now ‘incorrect’ based on the new way of valuing companies, the market ‘corrects’.
And the saying ‘when USA sneezes, Australia gets a cold’ seems to have played out as well. A drop in the USA often has flow on effects in Australian markets.
Is this a good or bad thing?
Well, it depends if there is something structurally wrong. If there is, a correction can turn into a large drop and a ‘bear’ market. This is what happened with the GFC. But if there’s nothing inherently wrong and markets have simply been running a little hot due to over-exuberance (and slightly optimistic assumptions), then a correction such as this is healthy.
In this instance, the overwhelming view is that things are structurally healthy, and that we’re going to see plenty more instability in the market after a prolonged period of record low volatility.
This is why it’s extremely important to have a long-term view when looking to invest and manage risks appropriately. There’s always ‘noise’ and repricing in the short-term. If you listen to the news, every single drop is a disaster.
But remember – the US’s record single day drop comes after their record increases. The Dow had gone up 30% in a 12-month period. It’s not logical for that to continue! As it stands, it’s still up over 20% for the year, which is a great outcome!
World economies are in decent shape and Australia is still growing. In fact, we’re still well ahead of where we were in October last year. Another good outcome.
In an ideal world, markets would continuously rise without falling. But in reality, it’s essential to have an investment strategy that will plan for drops in the markets. At Tribeca, our portfolios are set up specifically to handle volatility, whilst still providing you with a great chance of meeting your goals. This means that at the end of the day, short-term noise is irrelevant as you’ll have a plan to manage these risks and still meet your needs in the long-term.