Sentiment in sharemarkets has changed markedly in recent months: down and up. September’s extreme optimism had by December become near-total gloom, with many predictions of a bear market in shares. However, in the last week of December, investor confidence returned and built up further last week. These wide swings were experienced in sharemarkets all around the world, and followed the lead set by US shares.
Financial markets are often volatile. Sometimes the big moves are caused by “fundamental factors” such as a turn in the economic cycle or a major change in economic policy. We can call that a real crisis. More often, though, they reflect powerful swings in market sentiment: a change of view that gathers hold, is adopted by an increasing number of investors, feeds further on itself, is then dropped, and the market panic is later recognised as an overreaction or a false crisis.
From my observation and experience, these three points should always be in investors’ minds:
● Over time, patient investors are well-compensated for the discomfort of the bumpy ride that comes with share ownership. In Australia, shares have, on average and over time, returned a pleasant 10 per cent a year to investors, or 7.5 per cent after inflation. Over the long haul, future returns will likely be broadly similar.
● Investors need to allow that the prevailing sentiment in investment markets can at times turn out to be wrong.
● Whether a sharemarket crisis is real or false, it can provide opportunity to buy quality shares cheaply.
Looking back at late last year, share investors did have plenty of things to be worried about. But the prevailing expectations for gloom and doom came to be seriously over-done. As some of the big concerns will likely raise their heads again in coming months, let’s try a list of the main points to watch.
US monetary policy
In December, investors generally expected the US central bank to continue its program of gradually increasing its cash rate through 2019 — most likely ending the year with this key rate (currently 2.5 per cent) above 3 per cent. Last week, the Fed changed its earlier reference to the likelihood of further increases in the cash rate. The key words now are “in light of global economic and financial developments and muted inflation pressures (the Fed) will be patient as it determines what future adjustments (in the cash rate) may be appropriate …” My guess is there’ll be no change in the US cash rate this year. The Fed also said it was prepared to slow the pace at which it sells down the holdings of bonds acquired after the global crisis.
US recession
Many predictions were made in the December quarter of the early demise of the US economic upswing which, if it continues to this June, will have run for 10 years. But US consumer spending is strong, job numbers have risen, and the more cautious approach of the US central bank should cheer the markets. The main worries for the US are the tensions with China on trade and IP, the heavy indebtedness of many US corporations, and the huge deficit in the US budget.
China
China’s economy has slowed cyclically and in trend terms; the trade wars are a worry and debts are high for government, companies and households. But prospects for a hard landing in the Chinese economy are often exaggerated by Western observers. China has already started putting in place easier settings in budget and monetary policies — and, short of a major policy error, should avoid recession this year or next. Nonetheless, investors must expect financial markets to overreact when China’s purchasing managers’ index shows scores of less than 50 points (which markets will interpret, incorrectly, as a “contracting” economy).
Trade and IP wars
The US has agreed deals on tariffs with Canada, Mexico and Europe and now seems ready to negotiate a trade deal with China. However, aspects of the dispute over intellectual property will probably be difficult to resolve.
Australian politics
An Australian election is coming, probably on 18 May. There’s a high likelihood Labor will win office, probably with a minority position in the Senate. The Coalition, which has already lost its majority in parliament, is badly split on many important issues, and likely to use both sides of its budget — to be released in early April — to try to generate voter support. This will imperil delivery of the oft-mentioned budget surplus currently indicated for 2019-20.
Going into the election, policy differences between the Coalition and Labor will be wide, especially on negative gearing, taxation of capital gains, credits for franked dividends, the top tax rates on wages and salaries, and labour market regulation. My guess is Labor is seriously over-estimating the revenue its tax changes will raise and under-estimating the annoyance many people will feel from the treatment of franked credits.
House prices
The problems in the housing sector will slow but not derail the recovery in the broader economy. But beat-ups on the “housing crisis” will often aired.