A rebound in markets yesterday and overnight, driven mainly by a recovery in Japan and a drop in the value of the yen, ending the recent appreciation of the currency against the Euro in particular.
So perhaps we have a breather in the week-long instability on markets but according to the AMP’s head of strategy, Dr Shane Oliver, it’s not a problem to be that too concerned about.
He wrote yesterday :
· Share markets have entered a correction on the back of fears about global growth.
· The weakness may have further to run, but we see this as just another correction in a continuing bull market. Shares are not overvalued and global growth will slow enough to take pressure off interest rates but not so much as to crunch profits. Current sharemarket weakness may have further to run:
· Once a correction gets underway it often takes on a life of its own with market falls and worries about the outlook triggering the further unwinding of investment positions and hence further falls in markets.
· Measures of investor sentiment have not yet fallen to bearish extremes that mark market bottoms.
· Uncertainty about global growth may linger for a while just as inflation fears did around the middle of last year.
· The tail end of a US interest rate tightening cycle is often associated with a financial crisis. This is what happened in 1990 with the US Savings and Loans crisis, 1995 with Orange County and Mexico, 1997 with the Asian crisis and in 2000 with the tech wreck.
These aren’t all bad for shares and they usually mark the low but they do add to volatility. The problem in sub-prime loans is a current candidate for the next financial crisis.
· There is a risk that this bout of weakness will be deeper than those of the last few years. The bull market is now further advanced, more investors are now on board the sharemarket train and there are more leveraged positions. Also, interest rates are higher and profit growth is turning down suggesting economic risks are greater. Corrections in sharemarkets have been getting deeper over the last few years.
In 2004 the biggest correction in Australian shares was 3.5%; while 2005 saw two 8% corrections and last year shares had a 12% correction.
…………………….
While shares may have more short-term downside, this is likely to be just another correction in a still rising trend as opposed to the start of a bear market.
1. Sharemarkets were never overvalued. Thanks to very strong profit growth, the ratio of global and Australian share prices to consensus twelve month ahead expected earnings (the forward PE) is still not that far from its 2003 bear market lows.
We have yet to see the period of PE multiple expansion that characterises the final stages of bull markets.
2. As there has never been a severe inflation problem interest rates have not been increased enough to cause a collapse in global growth. While global growth is in the process of slowing, a profit crunching collapse is unlikely. In the US, housing and consumer spending have slowed but a strong corporate sector will underpin capital spending and employment growth.
3. With inflation fears receding on the back of moderating growth, interest rates are likely to remain low and may soon even start to fall in the US. This means that the flow of liquidity into share markets is likely to remain strong. For private equity investors it means that the cost of capital to finance deals will remain low (and may even fall) at a time when potential sharemarket targets are getting cheaper.
We are expecting a mid cycle slowdown like those in the mid 1980s and mid 1990s where US growth slowed to around 2.5%. This allowed bond yields to fall and the Fed to take its foot off the brake, which resulted in solid gains for sharemarkets. This should provide a reasonable environment for global and Australian growth.
He says in conclusion:
Bull markets are characterised by steady advances and occasional sharp setbacks. We are certainly in the latter right now. While there may be further weakness ahead, this should not be seen as the start of a bear market.
The low inflation global economic expansion is likely to remain broadly intact and sharemarkets are not overvalued. The historical record indicates that 10% to 20% corrections are not unusual. In fact, they are quite healthy in ensuring sharemarkets and investors don’t get too exuberant.
