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Is the current correction temporary?

 

18 January 2019

House view

 

 

 

 

 

 

 

 

The share bounce in January is encouraging, but softer growth means such rallies remain vulnerable, writes Mark Rider.

The sharemarket correction intensified in December as growth and earnings continued to be revised lower across most markets.

Sharemarkets have recovered some of the plunge so far in 2019 but still remain well below levels reached in June to September 2018.

The sharemarket drop we have seen since October can be attributed to widespread loss of economic momentum and companies downgrading their earnings expectations, particularly in the powerful US technology and energy sectors.

While some market analysts see this correction as a ‘pause’ – similar to what happened in markets in 2015 – there are differences in the current situation which may mean this correction reflects more sustained headwinds than in 2015.

 

Data source: FactSet

More serious than a market ‘pause’

The difference in the 2015 ‘pause’ was the stimulus that China and the US injected into their economies that kickstarted the 2016 recovery. Today, those major economies are in quite different situations.

In fact, there are four key reasons the current market correction is not similar to the pause in growth we experienced in 2015.

  1. We’re later in the investment cycle now with unemployment low across most regions, meaning we are closer to the end of the long growth phase we’ve been in.
  2. The US yield curve is continuing to flatten but has yet to invert and the level of US rates is much higher now – when it inverts (with short rates above 10-year yields) this is a strong indicator of recession.
  3. One of the factors breaking that pause in 2015 was China’s sizeable economic stimulus program, and that’s something we don’t see happening now. While China is now easing policy, given its level of debt, we expect only moderate policy support to remain.
  4. While US rate rises may be paused by its central bank – given that inflation and financial market exuberance remain well contained – the level of rates in the US is significantly higher than in 2015, and the US Federal Reserve will likely continue to reduce the size of its balance sheet.

Just as other major markets, the Australian sharemarket has corrected lower from its mid-2018 peak, but overall, Australian financial markets have been relatively resilient.

One key difference in the local market compared with 2015 is the recent fall in house prices. While that decline doesn’t appear to be causing stress yet, if the global economy doesn’t regain some momentum, the effect of house price declines could be magnified in the Australian economy.

 

Data source: FactSet

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The correction could be a good thing

The current correction is somewhat unusual as it was not preceded by clear signs that economies are entering recession.

In the kind of environments we are in now sharemarkets tend to become significantly over valued. But since October they have corrected sharply (with valuations across most markets now on the cheap side of ‘fair value’), with price-earnings multiples discounting sharply slower growth, tending towards a mild recession in 2019-20 across most markets.

In this light, the current correction is directionally correct and has occurred prior to the normal recession indicators. From this perspective, the correction is a good outcome as it could act to lengthen the current economic expansion.

Trade wars, Brexit and possible political instability across the US and Europe continue to curb investor sentiment. Though a pause in US rate rises is a positive for investors, it’s unlikely to be the major force driving the January bounce. That is likely due to investors being encouraged back into the market due to the large decline in valuations and sharply weaker sentiment from the past few months.

But until growth momentum stabilises we consider such share rallies will remain vulnerable.

ANZ investment strategy positions

Until it’s clear that the slide in growth has levelled out we are holding ‘neutral’ on growth assets such as shares. Our preference is for rate-sensitive, low-volatility defensive growth assets.

 

Investment position
Asset class Preference level Reasoning
Growth
Global equities Neutral Following the recent correction, valuations across most markets are now on the cheap side of fair value.
Australian equities Neutral Valuations are on the cheap side of fair value. We expect equities to perform well given attractive yields.
Emerging-market equities Neutral Valuations are on the cheap side of fair value. The stronger US dollar and China’s policy easing are key factors.
Listed real assets1 Neutral Valuations in global listed property have recovered from the recent correction.
Defensive: fixed income
International Underweight Fixed income has rallied due to slowing global growth and oil price collapse.
Australia Neutral Moderately expensive in value. Inflation expectations are subdued compared to the rest of the world.
Cash2 Neutral  
Currency
AUD Neutral At its current level, the Aussie is below fair value.

Notes:

Equities, fixed income, cash and currency are relative to benchmark.

1. Comprises of 50/50 split between global real estate investment trusts and infrastructure securities.

2. Cash is the balancing asset class.

 

As at January 2019.

Read the full Chief Investment Officer House View (PDF 207kB)

 

Mark Rider, Chief Investment Officer

Mark is responsible for delivering an overarching investment strategy, including asset allocation, investment themes, investment manager and product selection and monitoring for ANZ Wealth in Australia. Before joining ANZ in 2013, Mark spent 15 years at UBS and 10 years at the Reserve Bank of Australia, making him a well-recognised and respected member of the Australian investment community.

 

To discuss what this insight could mean for you, talk to your ANZ Private Banker directly, or contact us below

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