Why the markets have wobbled this week

You’re probably aware that global share markets have had a rocky week.

At the time of writing, the US share market (the S&P 500) is down by 8.5% for the month of February to date.

As scary as that may sound, it’s largely back to where it was in late 2017. In fact, the S&P 500 is still up by 7.7% for the financial year to date.

As usually happens, the Australian market followed the US. The ASX 300 (including dividends) is down by 2.5% for the month of February to date, but still up by 5.5% for the financial year to date.

History

Despite the alarming headlines, it’s quite normal for share markets to experience a 5% to 15% correction, particularly after a strong performing year.  

The S&P 500 sold off by 12.4% in 2015 and then sold off by 13.3% in late-2015/early-2016.

Neither turned out to be the start of a feared “bear market”, as US shares performed very well in 2016 and 2017.

So how can all this seemingly good news out of the US be bad news for shares?

As we wrote in our last quarterly market update, share markets are “forward looking”, so it’s often the case that returns from shares will dip before economic growth dips.

In this case, the problem (especially in the US) is that recent economic data has been so strong that markets now fear the return of inflation.

In turn, the markets fear that the US Federal Reserve will have to raise interest rates (perhaps sooner than the market expected). 

Inflation has become a concern for markets, as seen by the US 10 year bond yield, which has risen from 2.41% at the start of the January to 2.82% on 8 February 2018.

That’s bad news for bonds (when bond yields rise, bond prices fall), which has prompted the sell-off in US shares.

The US share market hasn’t had a decent correction since Donald Trump became president in November 2016.

Investor confidence has been very high and markets have been left vulnerable to a pull-back on the basis of relatively minor news, such as the January US jobs report (which came out on Friday, 2 February 2018) and indicated that wages were rising at the fastest rate since June 2009.

This week’s downturn has also been exacerbated by the melt-down of so-called “short volatility structured products”.

These complex products were created to allow people to bet that the abnormally low volatility we have seen in recent years will continue (or go even lower).

As inflation fears rose, shares fell and volatility rose, many of these products became forced sellers, which has put further pressure on US shares on its down days this week.

LUCRF Super has no direct exposure to these complex products, but the indirect pressure from their forced selling has put pressure on all share investors and exacerbated the volatility we are seeing in markets. 

Looking ahead

Only time will tell if the US share market rebounds in 2018 like it did in 2016 and 2017, but the conditions that predicated a major bear market of -20% or worse (like the Global Financial Crisis of 2008/09) largely do not exist in 2018.

“Good news is bad news” can lead to pull-backs in share markets like we have seen this week, but a proper bear market generally requires share markets to believe that a recession is imminent.

Whilst anything is possible, we do not see this as likely yet.

Steep share market falls are stressful, but selling shares or switching to a more conservative investment strategy after a market fall does lock in a loss.

We try to employ a long-term investment strategy and, although the recent market falls create a lot of noise, it is important to stick to the long-term strategy.

We are watching a number of factors closely, particularly as we move to the latter stages of this economic cycle, but not a lot has fundamentally changed in the global economy in the last week. 

How to respond?

It’s hard to forecast how returns may evolve through 2018, but we would not be surprised if volatility stays higher than we have become used to in recent years, mainly because markets had become used to abnormally low volatility.

As we have written in recent quarters, the best antidote to higher volatility is diversification. Now is a difficult time to just pick one asset class that is going to outperform all others.

We would continue to encourage members to keep their super or pension invested in a diversified option (or a diversified mix of options) in this environment.

Call one of our fully qualified financial advisers on 1300 130 780 to help you decide the investment option(s) that’s right for you.

News vs noise

It’s almost impossible to avoid the news about sharemarket falls. For instance, some ABC bulletins led with a headline of “$60 billion wiped off Australian share market” on Tuesday evening (6 February 2018).

Interestingly, you never hear a headline of “billions added to the share market today”.

Some news bulletins also led on Tuesday with headlines that the Dow Jones Industrial Average (“the Dow”) had its “single biggest point fall in a single day” (Monday, 5 February 2018).

Whilst that is technically true, the reality is the Dow is larger in index points than it has ever been, so it has a lot more points to lose. The size of a fall should ideally be measured in percentage terms, which was -4.6% on Monday.

Since 1980, there have been 37 days worse than Monday’s fall.

On 19 October 1987, the Dow fell by 22.6%, which is a proper crash.  

A Note on Crediting Rates

As you may be aware, LUCRF Super’s crediting rates are typically calculated on a Monday valuation date.

An exception to this rule occurs at month end if the Monday either falls within the first or last three business days of the month whereby we typically strike a rate at month-end and then defer striking another rate until the second Monday of the month.

That was the case this month, meaning that crediting rates were calculated with a valuation date of Wednesday, 31 January 2018 and the next set of crediting rates were not due to be calculated with a valuation date of until Monday, 12 February 2018.

There is a provision for the Trustee to calculate a crediting rate more often as it deems equitable.

Given the extreme market volatility this week, the Trustee has elected to calculate a crediting rate with a valuation date of Wednesday, 7 February 2018.

That means if you placed an investment option switch before 11.59pm AEDT on Wednesday, 7 February 2018, the 7 February crediting rate will apply to your account balance, before switching to your new option(s).  

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