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Market falls: Sort the signal from the noise


Shares invariably go through volatile patches

Globally, while volatility is likely to remain high and a further correction is possible, we see little risk of a recession or bear market in global shares at this point in time. What we have is a sharp adjustment of market sentiment and extreme fear without a real change in the underlying economic backdrop.

Sort the signal from the noise

While sharemarket falls can be distressing, they are a normal part of the way the sharemarket works. Market falls are usually made worse by recessions (notably US recessions) and a combination of prior overvaluation, investor euphoria and significant monetary tightening. While current sharemarket falls could still have further to go, our analysis suggests that economic fundamentals remain strong.

There is a lot of pessimism around but shares invariably go through volatile patches with corrections and bear markets that can linger for a while, but also provide solid returns over the long term. Shares literally climb a wall of worry over many years with numerous events dragging them down periodically, but with the trend ultimately rising. This can be seen in the next chart.

Source: ASX, AMP Capital

Assessing the situation in China

China will remain a source of volatility as it transitions from relying on manufacturing and investment to services and consumption and as the authorities remain on a steep learning curve as they deregulate the Chinese economy. This does not mean the Chinese economy is about to plunge into recession.

We expect the Chinese government will support economic growth through strong monetary policy easing and other measures which, in turn, should help support growth in China and the broader emerging markets. We will continue to watch and monitor the market, and will make necessary changes to our portfolios as the situation evolves.

Global outlook

While it’s been a poor start to the year for equity markets, and risks do remain high in the short term, our expectation remains for better returns this year than we saw in 2015. Share market valuations are reasonable – being cheap relative to bonds and bank deposits – and global monetary conditions are likely to remain very easy which should help ensure a rising trend in share markets.

What does it mean for Australia?

The latest bout of global growth worries warns that the global environment Australia faces remains messy; the global growth outlook is around 2.5%. Ongoing commodity price weakness means ongoing pressure on the budget deficit, points to more downwards pressure on the Australian dollar and more pressure on the Reserve Bank of Australia to cut interest rates again.

Final thoughts

Sharemarket falls boost the medium term return potential from shares – simply because they make shares cheaper – and once share markets bottom they are invariably followed by a strong rebound. Trying to time the bottom though is always hard, so averaging in after falls makes sense for those looking to allocate cash to shares.

About the author
Nader Naeimi, Head of Dynamic Markets at AMP Capital. He is also the portfolio manager of the Dynamic Markets Fund.
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