Originally published by IG Markets
The S&P/ASX 200 received a walloping yesterday, apparently carrying every skerrick of negative sentiment over from the night prior's Wall Street session.
One day up, the next day down: True to theme today, SPI futures are indicating an 73-point jump for the ASX200 at the open, following the recovery witnessed in US shares overnight, and the better than expected activity in European shares. There's the impression in markets currently that this variety of volatility may stay the norm for a while: days of radical losses, followed by rapid recoveries. The primary worry for index traders however, is that as it stands, the up days aren't as strong as the down days. That is: these markets are making lower lows and lower highs.
From correction to bear market? It's for this reason that market participants stood up and noticed yesterday's violent activity -- the question being, is this a sign of a bearish trend to come? The ASX entered into technical correction mode, defined as a 10% drop from highs, brought about by a broad evacuation out of equity markets. 2018's gains have hence been wiped clean, taking the index close to a very sticky point of support/resistance at 5620, lasted seen in October 2017 when the market was in a rather clear accumulation phase. An entry into this realm for the Australian market would be as good as any indicator that its recent medium-term run higher is over – and is poised for a much-needed shake out.
ASX fundamentals underwhelming: The broad fundamentals of the market support this notion if the trading activity in the ASX200's most weighty constituents is assessed. The top-down themes that pushed the index to decade long highs this year proved some combination of the rejuvenation of the global growth story, the strong global appetite for riskier momentum/growth stocks, and finally sporadic (and fleeting) recoveries in the major bank stocks. Assuming these themes have become exhausted, given the beneficiaries of this dynamic have predominantly been the highly weighted financial, mining (which, as an aside, could find its feet again if the bull market in iron ore continues) and healthcare stocks, it stands to reason that a wash out in the Australian equity market is due and the ASX200 still has scope to fall.
Wall Street’s impact on ASX: On the idiosyncratic behaviour of the ASX200, it's easy but all too simplistic to entirely conflate its fortunes with that of Wall Street's. The correlation is strong, as it always is, no doubt; however, the Australian share market's correction is at a different and more mature phase than its US counterpart. To emphasise: it's what is making investors nervous and the bears hungrier: technical indicators are suggesting that the formation of bearish patterns in prices are emerging. It appeals to the notion that Wall Street indices are beginning to converge with the rest of the world, and being dragged nearer the bear market realm occupied by equities across the Asian and European regions.
From panic to opportunity buying? Though this description sounds dour, in the big picture, it's a god awful small affair. The activity on financial markets is not yet deserving of panic; instead, it remains an opportunity for re-evaluation amidst changing circumstances. A correction in markets is necessary and intrinsic to their function, as misallocated capital attempts to find a new home. This is especially true now as global monetary conditions tighten for the first time in over 10 years -- a phenomenon only reaffirmed by the ECB's announcement at its monetary policy meeting last night it would begin tightening its QE program this December. It's a major structural shift in financial markets, ultimately culminating in the understand that free money is no longer available, and investors must become more discerning.
Value and a search for yield: In the Australian experience, this manifests in stocks that have sold-off aggressively in the last month, such as the likes of market-darling CSL (AX:CSL). The dumping isn't necessarily reflective of company fundamentals, but a shift in market behaviour: the constant bidding up of stocks considered high growth by momentum traders is disappearing, resulting in a fall in the stock's price. It hurts for those who bought-in at the highs, but it opens opportunities for value-investors to take control of the price, and drive stocks higher on that basis in the long term, instead.
This evolving dynamic is being demonstrated more acutely than anywhere else in the action in the NASDAQ. Investors have grown weary of chasing capital growth or the next "unicorn", favouring instead the safe returns in cash and fixed income, which at over 2 per cent if using 1 month Libor as a crude benchmark, outstrips the yield delivered on much of the stocks on the NASDAQ. It's another example of how a correction is not a signal to panic, but one that indicates a time to appreciate changing circumstances and the necessity of a new trading/investing outlook.
Growth risks still require consideration: Granted, this correction isn't solely predicated on just changing monetary policy conditions and its subsequent impact on the risk/reward relationship. The impacts of potentially weaker growth from tariffs and softer than expected economic conditions outside the US have been flagged by US corporates during this week's reporting period as risks to profitability. It's effectively what's triggered this latest sell-off: investors could stomach some of the effects of higher discount rates on valuations if earnings growth could (on balance) outweigh its impacts. The weaker outlook for 2019 delivered by US business has cast doubt in the minds of investors whether this will prove so, and this precipitated an aggressive rotation in markets.