Wealth Management – Market Update

2016 has seen markets across the US, Eurozone & Asia suffer losses in excess of 5% and up to 14% while Australian Shares have fallen over 6%. This has seen markets fall to levels seen throughout the second half of 2015. Concerns are centred around the Chinese economy, the US Federal Reserve raising interest rates and the impact of the rising US dollar against the falling Chinese Renminbi. The falling oil price has also effected markets and has again raised concerns over emerging markets.
It is important for all investors to remember that selling after big declines will only realise losses while existing diversification will help to reduce overall portfolio volatility and continue to provide adequate income. The concerns regarding China and its regulatory issues as well as the monetary tightening in the US could result in further short term declines however given the US market's influence on global shares and it's unlikeliness to fall into a recession, any pessimistic discussions of a "GFC style" event should be quelled .
Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital shares the 7 reasons not to be too concerned.
First, the latest fall in Chinese shares arguably tells us more about regulatory issues and fears around the share market and currency rather than much about the economy. Recent economic data out of China has been mixed rather than outright negative. Rather the main drivers have been worries about new share supply following the end to a ban on selling by major shareholders, a new share market circuit breaker which perversely encouraged investors to bring forward selling, and a continuing depreciation of the Renminbi against the $US.
In terms of each of these: Chinese regulators have since announced a restrictive limit on the size of stakes that major investors can sell; the circuit breaker has now been suspended; and after a 6% plus depreciation in the value of the RMB since July the PBOC appears to be stepping up its effort to stabilise it and indeed some stability has returned in the last few days. Our view remains that Chinese growth this year will come in around 6.5% and ongoing stimulus measures appear to be gaining some traction in helping ensure this.
Second, a US recession is unlikely. This is critically important as the US share market sets the direction for global shares and the historical experience tells us that slumps in US shares tend to be shallower and/or shorter when there is no US recession and deeper and longer when there is (eg the tech wreck and GFC). See the next table. Sure US manufacturing is soft thanks to the strong $US and softening resource investment. But against this we have seen none of the excesses that precede recessions – like excessive growth in private debt, over investment in housing or capital good, high inflation or a speculative bubble. And most economic indicators in the US are okay highlighted by continuing strong jobs data which is serving to keep consumer spending firing even though the strong $US has damped US manufacturing. Nor have we seen 17 Fed interest rate hikes or the move to an inverted yield curve as we saw prior to the GFC.
Third, the combination of okay economic data in China and the US along with good Eurozone indicators lately indicate the global economy is unlikely to plunge into recession. Sure while manufacturing conditions PMIs globally have been a bit softer lately, services conditions indicators remain reasonably solid.
Fourth, the current dynamic is very different to say the GFC as lower oil prices and commodity prices are providing a huge boost to consumers and most businesses. This is unlike the US housing slump at the time of the GFC that froze credit markets and led to a huge loss of household wealth or the surge in oil prices that preceded the GFC.
Fifth, monetary policy remains ultra easy. The Fed is very unlikely to undertake the four rate hikes it’s signalling for this year and other countries are still easing. This is very different to prior to the GFC when monetary tightening was the norm.
Sixth, renewed sharp falls have seen share market valuations become quite attractive. Our valuation measures for global and Australian shares have fallen back into very cheap territory. The gap between the grossed up dividend yield on Australian shares which is now nearly 7% and term deposit rates around 2.5% is back to around its highest level since the GFC.
Finally, there is a lot of pessimism around. This is evident in headlines screaming “RBS tells investors to sell everything” to “Collapse 2016”. Then again you might say such extreme views always exist. True. But they are suddenly all landing in my inbox telling me that such headlines are getting much more interest and belief. In some ways this is a negative as it is creating more fear amongst investors, but the flipside though is that when everyone fears the worst, often the surprise is that things turn out to be better.

Implications for investors
Investors need to allow for several 
  • First, shares invariably go through volatile patches with corrections and bear markets that can linger for a while, but also provide solid returns over the long term. Shares literally climb a wall of worry over many years with numerous events dragging them down periodically, but with the trend ultimately rising. This can be seen in the next chart.
  • Second, China will remain a source of volatility as it transitions from relying on manufacturing & investment to services & consumption and as the authorities remain on a steep learning curve as they deregulate the Chinese economy. But this does not mean the Chinese economy is about to plunge into recession.
  • Third, selling after a major fall just locks in a loss. Shares may only be down say 6% year to date but measured against last year’s highs many developed markets including Australian shares are already down 15 to 20%. For those concerned, one way to protect against downside is to have an exposure in unhedged global shares because further worries about global growth will further depress the $A which will in turn boost the value of offshore investments.
  • Finally, while shares may have fallen in value the dividends from the market as a whole have continued to increase. So the cash income flow you are receiving from a well-diversified portfolio of shares has continued to remain attractive, particularly against bank deposits.  
For more information please contact:

Neal Dunne
Moore Stephens Victoria
P +61 3 9608 0170
E ndunne@moorestephens.com.au