The recent downturn in share markets is distressing and confusing for investors. The emotional charged coverage of the market turmoil and the multitude of conflicting views can derail even the most disciplined investor.
It can be helpful to step back from this noise and view the current events in perspective.
Other sources that are useful in this regard include:
Olivers Insights:
The US loses its AAA rating from S&P. Not good but maybe not as bad as fearedSlumping global sharemarkets and debt debacles
Ipac:
Recent events and global sharemarketsPast posts (covering European debt issues)
Greece is going to come back into the splotlight (May 2011)
Greece – The fire is out, but there are still problems (May 2010)
Big market falls after a strong rise
The US sharemarket has fallen by 13 per cent over the past week, and nearly 17 percent over the last 4 weeks. Panic trading during the past few days has fuelled some of the largest one day declines since 2008.
While substantial, these declines need to be viewed in context. Investors should note:
• Markets have risen strongly since the GFC
The falls in the US sharemarket have followed a very substantial rise in global markets since the Global Financial Crisis (GFC). Despite economic concerns, the US sharemarket has been one of the best performing in the world. From a low point in March 2009, it gained almost 100 per cent through to early July this year. Even taking recent market weakness into account, the US sharemarket is still up by 65 per cent since March 2009, as shown by figure 1.
The Australian sharemarket has also fallen sharply over recent weeks, posting a decline of 11 per cent in the last week. While the market is now also back to similar levels reached in August last year, it still is almost 30 per cent higher than its lowest point in March 2009, as shown by figure 2.
Figure 1: US sharemarket since January 2009
Source: Datastream, data up to 8 August 2011
Figure 2: Australian sharemarket since January 2009
Source: Datastream, data up to 8 August 2011
• Markets are cheaper and profits increasing
The rise in the US sharemarket reflects the strong performance of US companies – company profits have risen by 94 per cent since December 2009.
Even though profits have continued to grow, share prices are now back to the levels of a year ago. This means that shares are now cheaper than they were a year ago.
This holds true whether we are considering price relative to profit, or price relative to book value.For example on a p/e basis, US and Australian shares are currently trading around 30 per cent cheaper than their long term average.
Panic in the share market is ironically driving high demand for US treasury bonds and the US dollar, despite the fact that these are now very expensive, low yielding assets. The yield on shares is now higher than the yield on bonds – historically a clear sign of relatively cheap share valuations.
It’s bad – but not all bad
As markets fall, news reports are uniformly negative. The media has been relentlessly negative, peppering reports with words such as ‘meltdown’ to ‘Armageddon’. No wonder fear has been the order of the day.
The focus on negative developments in the US and Europe is understandable. But that doesn’t mean that nothing good is going on – it’s just not ‘news’.
To help balance the scales a little, it’s worth considering some of the positive trends with an unapologetically one-sided list of ‘good news’.
• The world is experiencing solid economic growth
The world returned to positive growth quickly following the global financial crisis, returning to positive growth in 2010. According to the IMF, growth for 2011 and 2012 should exceed 4 per cent.
Even though forecasts may be lowered, any further economic slowdowns in the US and Europe are unlikely to pull the entire global economy into double dip recession.
The developing economies now comprise more than 50 per cent of the word economy, and according to the IMF, they are expected to grow at more than 6 per cent over the next few years.
The strength of the developing economies provides an important counter weight for overall global economic growth.
Importantly for Australia, China – now Australia’s major trading partner for both exports and imports – is growing at more than 9 per cent per annum.
• The Japanese economy is rebounding sharply
Japan’s economic growth is showing signs of recovering more quickly than expected from the negative impact of this year’s natural and nuclear disasters. The forecast growth for 2012 has been around 3 per cent, and this may be exceeded. For example, Toyota, which manufactures more motor vehicles in Japan than other Japanese manufacturers, has now revised its forecast profit up by 39 per cent for the full year, noting a quicker than expected recovery from the March 2011 earthquake and tsunami.
• The new US budget constraints won’t add to the risk of a recession
The US Congress resolved to approve an increase in the government borrowing limit after agreement had been reached on the US Budget Control Act. This act requires adjustments to the Federal Budget, which are estimated to reduce the US deficit by $2.1 trillion dollars over the next decade.
Markets reacted with concerns that these cuts would slow US economic growth to the point of recession.
As shown in figure 3, US government policy was providing a boost of more than 1.5 per cent to economic growth when it was needed in 2009.
The withdrawal of that stimulus was expected to detract around 1.5 per cent from growth in 2012. The US Budget Control Act only marginally increases this impact. On its own, these measures are not enough to shift the outlook from growth to a recession.
Figure 3: Contribution of US fiscal policy to US GDP growth
Source: The Economist
• The Australian economy is well placed
With a low government debt of 24 per cent of our economic output, strong growth, low unemployment, and record demand for our exports, the Australian economy is very well placed to absorb global shocks.
Australia’s AAA credit rating is solid.
• Some inflationary pressures are falling
From their peak last year, oil and food prices are down by 15 to 20 per cent, reducing inflation pressures.
• The global banking system is in a stronger position post GFC
Recent stress tests undertaken by the International Monetary Fund (IMF) have shown European banks are in sound shape.
• Corporate balance sheets are in very good shape and profitability is increasing
On the whole, corporate balance sheets are in good shape with low levels of gearing and high levels of excess cash.
• The long term track record of the market is compelling
Among all of the disasters, crises, and disruptions that have impacted markets over the past century – many have seemed much more serious than the concerns we currently face.
And yet over time, the stock market has always finished higher. Throughout the entire period since 1900, the Australian market has returned 11.8 per cent per annum, despite all of the bad news that could be thrown at it.
Acting, not reactingWatching others aggressively selling in the markets understandably creates a massive desire to do the same. But this approach crystallises a loss and prevents any long term investor from realising gains when the markets eventually stop panicking and start to price in strong underlying profit growth.
Confidence is at an all time low at present – it may not seem like it now, but confidence will eventually improve in the future, potentially unlocking significant value in the markets.
