The month of October has seen a spike in equity market volatility with the All Ords down nearly 10% from their highs earlier this year. Market confidence was high last quarter and the recent strong August reporting period delivered a reasonable result for corporate Australia.
Context is important and there have been a number of factors globally and domestically that have resulted in the recent elevated market volatility. There has been a significant divergence this year between the emerging markets and the developed markets. The strong US dollar year to date has led to a very deep and prolonged emerging market rout that has worsened as the year has progressed.
The improving US economic momentum following many years of low rates, the fiscal stimulus of late 2017 with the US tax cuts and the trade wars have all combined to drive a higher US dollar and lead to an acceleration in US economic activity and therefore improving US corporate earnings. This is happening at a time when global growth momentum is slowing from the recent peak. This has been verified by the IMF which recently lowered their forecasts for global growth.
Following years of synchronised global growth (and synchronised global policy stimulus) we have moved into a period of de-synchronised global growth with the worlds largest economy, the US growing strongly and the rest of the world effectively slowing. Further, the rising US Fed Funds rate is reflecting the accelerating US economy. The resulting strength in the USD has placed significant pressure for some emerging economies that service their liabilities in USD. Further, the trade wards are starting to impact supply chains and this leads to a slow-down in global trade, impacting shipping, which further amplifies the negative impact for emerging economies.
When equity valuations are no longer cheap you tend to get a rotation from investors into more defensive assets following many years of equity gains. This occurred increasingly in the September quarter. Further, investor sentiment has been impacted with the global trade wars between the two largest economies, the US and China. With the US quarterly reporting period delivering very robust earnings numbers, while the rest of the whole is showing slowing conditions, there will continue to be a mixed investment landscape and investors beginning to doubt the appropriate valuation for future earnings. This therefore leads to increased market volatility which looks to remain elevated into 2019.
In Australia our equity valuations have not been compelling enough for global investors and local institutional superannuation funds have increased their global equity exposures vs domestic equities significantly over the past decade. Domestically SMSF are the core default investor in Australian equities, in part due to the fact of the preferential tax treatment of income for those in pension phase. The dividend and the franking will continue to be more compelling for the domestic investor for some time and they would simply need to ride out market volatility given they are invested like a value manager, over the long run cycle. The silver lining for local investors is a lower AUD will broadly act as a cushion for the local economy. For companies that receive USD earnings, they will obviously benefit even more.
As we head into year-end, global sentiment will continue to be impacted by trade wars, global de- synchronised growth, US interest rates, higher energy costs to name a few. While elevated equity market volatility will continue for some time with this global back drop, your investment timeframe and asset allocation are important and should reflect your risk appetite as you diligently work to achieve realistic expected returns.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Tuesday October 30, 2018.