Take a deep breath, there’s no need to panic yet

It’s natural to be feeling skittish following last week’s market turbulence, but if you ask me, we should all take a deep breath and move ahead with a little less panic.

The fall in the S&P500 has returned it to the same level it was at in early December last year – yep, just two months ago. For the ASX200, it dropped as low as mid-October levels. It’s not unusual that the Aussie market falls are disproportionately to the S&P500.

The recent drop was triggered by a sharp increase in US wage inflation, but this was simply a catalyst for a market that was well overdue for a correction. For quite some time now, I have been writing that investors are underestimating the number of rate hikes the US will need to make in response to stronger growth.

I not am convinced that this is the start of a major correction, not yet at least. Why?

  • It is the wrong time of year
  • The fundamentals remain healthy for now
  • There is no sign of a US recession (in fact it’s the opposite).

I’m not suggesting the strong gains of 2017 will be repeated in 2018, but there are sources of comfort for investors – news on the global economy looks set to remain positive in the coming months and there are few signs of a more general upsurge in price pressures (notwithstanding the pick-up in US wages) that might prompt interest rates and bond yields to rocket.

Emerging markets hit hard as well

Whilst the US has been the main focus of the recent stock market turmoil, emerging market (EM) equities have also been hit hard. Benchmark indices of EM equities have fallen roughly in line with the S&P500 despite there being no fundamental reason for them to do so.

Recent moves in EM currencies, which have tended to be most vulnerable to tightening by the US Federal Reserve in the past, have not been especially large. With this in mind, we doubt there will be any respite for EM equities until the slump in the US stock market finishes. The fact that EM equity valuations are still low in relative terms may provide some comfort when the US volatility stabilises.

US Dollar strengthens

The recent turbulence in equity markets has provided support to the US dollar. It has strengthened against every other “major” currency since 26th January and also risen by more than 1% on average against emerging market currencies.

The dollar has even strengthened a little against the Japanese Yen and Swiss Franc, both of which are regarded as safe havens. This might suggest that the dollar has received help from safe haven flows, despite the fact that developments in the US are what seem to have triggered the market slump.

Given we don’t expect the volatility in the US equity market to continue, we don’t expect the dollar’s recent strength to persist either.

Australian data not as bad as it seems

The Reserve Bank of Australia left its policy rate unchanged at 1.50% at its recent meeting, and its comments suggest it is in no hurry to raise interest rates either.

Some recent data out of Australia may not be as bad as it seems. The 0.5% month-on-month decline in Australian retail sales in December appears to be because consumers simply brought forward their spending from December to take advantage of deals in November. Whilst the weakening of the Australian trade balance to -A$1,358m in December, is only because businesses are importing more machinery and equipment from overseas. This is actually a good thing as capital equipment investment in the past has led to a stronger employment environment.

 

 

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