Climate change, geopolitical instability and forced mass migration are creating many more displaced people in the world now than during WWII. Adding to this is an oil pricing slump and uncertain economic outlook globally. Recent sharemarket falls have built on this anxiety with concerns about Chinese currency depreciation and weak manufacturing data. But the stock market jitters really reflect faltering sentiment, rather than significant change to the fundamental data.
Of course it is unpleasant for investors but for a while we’ve been expecting increased volatility as the US raises its interest rates from near zero and China’s growth slows. So the cycle of market downturns followed by recovery is likely to linger for a quite a while yet, with slow growth and lower returns than in recent decades.
Company earnings estimates in the US are declining and oil earnings downgrades are restraining overall estimates. The rising US dollar retards US exports, while monetary stimulus no longer supports earnings growth and stock price gains. Despite recent falls, the US stock market is still fully valued – while our own market is fairly priced with a sluggish earnings outlook. For stock prices to grow from here, investors need evidence of ongoing US growth and smooth transition in China. Energy assets may stay underpriced for a while.
US employment growth remains strong though wages are growing at only 2.5%. The US services and housing sectors are still growing but manufacturing is weak. Because of this, US interest rates are likely to rise very gradually.
International equities still have a role in most portfolios – a rising US dollar will help earnings in US dollar-denominated businesses. There are also many great companies to choose from internationally. On a relative value basis, there may be some merit in overweighting Europe and Japan with lighter US exposure.
Emerging markets are currently experiencing higher risks right now as cash flows back to the US. China devaluing its currency could have a domino effect to larger falls in other emerging market currencies. But share prices in those markets have fallen for much of the last year, so some of this concern is already priced in. Even so, conservative investing is needed in this sector despite strong Asian market growth in decades past.
Globally, financial markets are anxious about China’s depreciating currency, its falling stock markets and shaky confidence in the Government’s policymaking control. But policymakers want to avoid a strong currency causing China’s growth targets to slip lower while they move towards a freely traded currency, driven by supply and demand. So, China is likely to gradually release more control over the yuan this year.
Essentially, the ‘easy money’ environment post GFC is changing. Cash flow is now more difficult as the US raises its interest rates and emerging markets sell their foreign exchange reserves to defend their own currencies. So, their borrowing costs are rising while returns on capital invested are falling – an unfortunate combination. But there are opportunities in EU markets and eventually some opportunities will appear in distressed emerging markets.
Is this a market dip you should buy into, or portent of a large crash ahead? If it’s a dip then buying into it with some of your funds may be best. But if a crash lies ahead, then keeping some additional cash just in case will feel better. You can never get market timing right consistently and those that say they will, later struggle to show they can repeat this. Those that do manage to sell before major price falls, generally are too slow to buy back in later.
Noises about the markets’ impending doom tend to get louder after a period of market weakness. Unfortunately, enough negative ‘market noise’ can make for doleful market sentiment that leads to it being misjudged as a fundamental fact. Without significantly encouraging data over the next few months, the current sell-off might become self-fulfilling, extending the global crisis (GFC).
In all this, take heart that stock markets have eventually recovered from every crash – unless you’re forced to sell while it’s down there. Though small consolation while awaiting such a recovery, dividend income from a broad Australian share portfolio is historically very reliable. So, it may be best to focus on the income and let the market ‘noise’ wash past you. Australian shares currently offer significantly higher dividend income than interest bearing alternatives. The trick is to choose those stocks that won’t need to downgrade their dividends.
Often it is bad news no-one expected that does the most share price damage, whereas freely predicted bad news can prove mild in hindsight. As ‘perfect’ investing isn’t possible, just make the best quality decisions you can, and don’t look back. Maybe we can help?