Understanding the dramatic sharemarket fall

9 February 2018

Mark Rider explains the volatile week in global sharemarkets when more than $55 billion was wiped off the ASX at one point.

A long period of calm ended this week with sharemarkets in the US, Australia and around the world falling dramatically.

At the lowest point, the Dow Jones Industrial Average – an index of 30 major US companies – was down 1597 points, a 6.4 per cent fall. By the close of the market on Monday the US market had reversed more than all the gains since the start of 2018.

With the US the biggest sharemarket by a large margin, global markets are heavily impacted when it moves, so it wasn’t surprising that Australian shares followed suit with share prices falling across all sectors.

Since then markets showed some signs of stabilising, before a renewed plunge on Thursday in the US, repeated in Australia on Friday.


So what happened?

January 2018 was a time of record inflows into global sharemarkets with investors pushing many sought-after assets into ‘overbought’ territory. This meant the market was vulnerable to any real or perceived bad news.

The US released some key jobs data last Friday which showed that wages were growing at a faster pace than expected. This meant investors feared the US central bank (US Federal Reserve or the Fed) may raise interest rates far more quickly than anticipated. Raising interest rates are typically a negative outcome for shares as investors worry about the outlook for the economy and company earnings, typically preferring cash and bonds.


Putting the market fall in context

Last year was not an ordinary year. One of the most followed US sharemarket indices – the S&P 500 – returned 19.42 per cent and had been within 3 per cent of an all-time high for an incredible 202 straight days due to abnormally low volatility.

This is almost twice as long as the second-longest streak which occurred from 1995 to 1996.

Periods of such calm are bound to end at some point, but it’s awfully difficult to know just when.


A focus on fundamentals

We see this move in markets as a correction, not marking a cyclical peak. As always, we remain focused on the market fundamentals.

As flagged in our last CIO Investment Spotlight we expected the strength in markets to fade as 2018 rolls on. Our investment cycle clock that helps us determine where we are in the investment cycle flags we are “late cycle” but still with some way to go, using history as a guide.

The economic and earnings backdrop is still very strong around the world and monetary policy remains easy, both supportive of share markets. In time, while inflationary pressures may reach a point of concern we are still short of a level that is troubling and would require a move to a defensive strategy.

We don’t see valuations or sentiment as extreme enough without cracks in the economic recovery to mark the market peak. The yield curve, which typically flags prospective economic growth, is also consistent with an ongoing economic expansion. We continue to maintain a modest preference toward growth assets.