Despite heightened market volatility, positive fundamentals still outweigh the uncertainties causing angst for investors and the media.
That’s the view of Six Park’s Investment Advisory Committee (IAC), which met in late November to review global trading conditions and the group’s asset allocation parameters.
The IAC elected to keep Six Park’s portfolio allocations unchanged, reiterating its view that fear rather than fundamentals appeared to be dominating market sentiment at the moment.
Several key markets benchmarks (mainly, the US indices) have recently moved into “correction” territory, meaning they have dropped 10-20% from recent highs. There are several drivers of this correction, but rather than the start of a true bear market, recent share market declines appear to be more of a return to how markets periodically move through down cycles.
Key global market themes that were considered at the recent IAC meeting included the following:
ESCALATION OF TRADE WAR RHETORIC IS CAUSING FEAR IN SHARE MARKETS
The IAC noted that trade-related “sabre-rattling” between the United States and China was increasing, with no obvious sign of which side was likely to back down first. However, on the prospects of a major trade war between the US and China, the Chinese and American economies are tightly connected, and therefore the prospect that either country actually imposes significantly punitive policies still seems unlikely at this point.
“Further escalation will risk serious internal pain,” former Finance Minister Lindsay Tanner said. “Fundamentally, a trade war is about goods, which are a shrinking economy. It’s when Apple and Google stand to be seriously affected that there’s real risk.” The IAC does not see this happening yet.
SIGNS OF SLOWING GLOBAL ECONOMIC GROWTH IS CAUSING FEAR OF A RECESSIONARY ENVIRONMENT
Although there are signs that global economic may be slowing (and has started in parts of Europe), the likelihood of a major recessionary environment in 2019 remained low.
Mr Watson pointed out that overall fundamentals are still broadly positive, while US economic conditions and corporate profit results remains strong. “There’s certainly no reason the US should be feeling bad about itself economically,” he said. The IAC noted that if a recessionary environment were to play out, the consensus view was that it was most likely to occur after 2019 and, as such, economic growth over the next year was most likely to ease but not turn negative.
UNCERTAINTY AROUND BREXIT AND EUROZONE ACTIVITY IS ANOTHER UNKNOWN THAT IS TROUBLING MARKETS
The IAC characterised the UK “a mess” as it considers how to advance or retreat from Brexit, and said Italy was also looking increasingly challenged as a budget showdown with the European Union looms. These factors are likely to continue to create heightened uncertainty across European markets but are unlikely to be a material drag on global economic growth.
POTENTIAL IMPACT OF AN INCREASING INTEREST RATE ENVIRONMENT
Rising interest rates can be a headwind for equity markets (if unexpected or accelerated), but it was noted that the rising interest rate environment was driven mainly by positive factors in global growth and rates remain at historically low levels.
DOMESTIC SHARE AND PROPERTY PRICES SOFTER BUT NO NEED TO JUMP AT SHADOWS AT THIS POINT
The consensus view of the IAC was that recent pullbacks to the Australian share market and property market were probably necessary after strong gains over the past several years.
Key domestic risks include a regulatory-driven slowdown in mortgage lending and growth, and the possibility that politicians may pander to “populist demands” for immigration cuts.
Slackening house prices and auction clearance rates are likely to make people feel less wealthy, and credit conditions are tightening, but the IAC noted that there was still no need “to jump at shadows” despite several noticeable market pullbacks since October.
Corrections are a normal part of share market cycles (as occurred in February 2018). A variety of “unknowns” described above have caused fear in the market and as such many investors have shifted to more defensive assets, driving down global share markets.
However, Six Park’s IAC believes that there are still key positives in the global economy and we do not see the kind of asset pricing bubbles that lead to extreme (20%+) market sell-downs and/or a recessionary environment.
Six Park only shifts asset allocations when there is a fundamental long-term change in the markets that invalidates the historic data on which our asset allocations are based, and we do not see such a fundamental shift at this point.
History shows that the best strategy when markets pull back as they have recently is to ride out the cycle, stick with your investment plan, and most importantly, be patient.
Then and now: the IAC’s 2017 global outlook in review
In December 2017, Six Park’s IAC outlined several anticipated themes for 2018:
|OUTLOOK FOR 2018||WHAT ACTUALLY HAPPENED|
|“We expect the unwinding of fiscal stimulus to be gradual…Markets will almost certainly move off recent highs, though the timing, catalyst and magnitude is unknown.”||Domestically and globally, markets have suffered several sharp jolts, in March and between October and December, and volatility has returned to markets after an extended period of relative calm in the markets.|
|“Job growth has been strong even if wage growth is modest, and interest rates are expected to remain flat or increase slightly over the next year.”||Australian interest rates have now remained unchanged at 1.5% since August 2016.|
|“The domestic property market will likely cool off to some extent but is not an imminent valuation bubble about to burst.”||As suggested (and noted in update above), property prices have moderated in 2018 as lending conditions have tightened.|
|“Domestic political activities mimic the US to some extent: turbulence and possible changes, but nothing that is likely to seriously impact market or economic conditions.”||Scott Morrison replaced Malcolm Turnbull as prime minister in August after an ill-fated challenge by Peter Dutton. A federal election is slated for May 2019.|
As the IAC pointed out 12 months ago, a positive backdrop doesn’t necessarily allay anxiety among investors unable to filter out noise from those predicting a steep drop in share markets. You can learn more about the context of October’s market downturn and why it’s important to keep calm and stay invested in this article by Six Park’s director of strategy and analytics Dave Blumenthal.