The correction in share markets

Introduction

I have discovered after nearly 10 years that Taylor Swift is actually pretty good. Songs like Style and Shake it Off are right up there when it comes to great head candy. Not quite as good as say The Beach Boys of course but still up there. In my Holden, the next CD I had loaded after Taylor’s 1989 was a compilation of The Carpenters’ greatest hits (which got there after an obsession with the Johnny Depp film “Dark Shadows”) and I must admit that Taylor cannot generate the emotion inherent in The Carpenters’ songs where Karen’s voice and the production overlay of her brother can send me over the top.

So what’s this got to do with it? Not much really except that share markets are full of emotion and right now there seems to be a lot of nervousness around. In fact this has arguably been the case since April during which we have seen several major share markets have decent corrections, eg Chinese shares -32%, Asian shares (ex Japan) -17%, Emerging market shares -16%, Eurozone shares -13% and Australian shares. Of course the US share market has been relatively stable with at most a 4% pull back, although being virtually flat year to date it might be described as being in a “stealth correction”.

This note takes a look at the drivers of these declines and whether it’s just a correction or something more serious.

The short term worry list

In our view the correction could have further to run over the next few months with a reasonable worry list remaining in place.

 

Source: AMP Capital

Seasonal pain

Apart from these considerations it should also be recognised that the seasonal pattern for shares typically sees rougher returns over the period May to November. This is consistent with the old saying “sell in May and go away, buy again on St Leger’s Day (a UK horse race in September).”

Source: Bloomberg, AMP Capital

Is it a correction or something worse?

The important issue though is whether current weakness is just a correction or the start of a new bear market? Periodic sharp falls in the range of 5% to even 20% are quite normal and healthy in that they help the market let off steam and the rising trend resume. Of course it becomes more concerning if the rising trend in share prices gives way to a declining trend and a new bear market sets in. On this front our view remains that the cyclical bull market in shares likely has further to go. Put simply shares are not seeing the sort of conditions that normally precede a new cyclical bear market: shares are not unambiguously overvalued; they are not over loved by investors; uneven & below trend growth is extending the economic expansion cycle; and monetary conditions are likely to remain easy for a while yet. Looking at each of these in turn.

 

Source: Bloomberg, AMP Capital

 

Source: Bloomberg, AMP Capital

Concluding comments

First, while there is a high risk of a further correction in share markets in the next month or so, from a broad brush perspective we are not seeing the signs normally seen at major cyclical peaks in shares and so the cyclical bull market in shares looks like it has further to go.

Second, China and the Fed are probably the key risks worth keeping an eye on.

Third, while there will be cyclical bounces in commodity prices and emerging market shares the time to “blindly overweight them” was last decade and until supply imbalances in the case of commodities and structural problems in parts of the emerging world are resolved it makes sense to be selective and cautious when investing in them.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.