It’s understandable that the recent sharp sell-off on financial markets has left investors feeling particularly nervous. The main concern has been the US Federal Reserve’s shift in monetary policy from low rates and printing money to rising rates and the withdrawal of that printing policy.
But there’s also a lengthy worry list of issues that we hear continuously: the US trade conflict with China, issues around the leadership of President Donald Trump, and the economic and budgetary implications of the populist government in Italy.
After several years of good returns, all of this has created a degree of nervousness.
These levels of falls are technically a correction. We often go through periods of volatility where markets have set backs. You have a rising trend, but every so often you get a pullback of roughly 10%. The bulk of those pullbacks don’t go on to become major bear markets.
Could it turn into a bear market?
While corrections are normal, investors are right to ask whether this one is different. Is this sell-off the one that does represent the start of a major bear market?
History tells us that major bear markets come along when there is a US recession. The big bear markets of the mid-70s, early-80s, early-2000s (the tech wreck), and the GFC were all associated with a US recession.
To get a ‘grizzly’ bear market that really worries people – where prices fall 20% one year and then another 20% the following year – as opposed to a ‘gummy’ bear market – where markets fall say 20% and it feels horrible, but a year later you’re up again – you really need evidence that the US is going into a recession.
But if the US isn’t about to go into recession, and earnings continue to grow and interest rates remain relatively low, the odds are that this turns out to be just another correction, which we see a lot of.
A US recession is unlikely
Our view is that a US recession is still some way away and for now it’s unlikely. A lot of the things you normally look for as a guide to whether the US is going into recession are just not there. We haven’t seen the same degree of over-investment, wages growth is still relatively benign, and the US Federal Reserve is still a long way from adopting tight monetary policy.
One of the big worries for investors has been rising interest rates. But interest rates are rising because economic conditions are good. That’s something we have been hoping for for almost a decade: that things would go back to normal. The US Federal Reserve is only raising interest rates because the emergency is over, and the US economy can come off the medicine.
Of course, at some point a recession will inevitably happen, even though in Australia we have managed to avoid one for a long time. But in the US, it’s probably still at least 18 months away. The normal circumstances that precede a US recession just aren’t evident, and they’re not evident in Australia either.
Take a long-term view
The thing to do now is to take a long-term view and recognise that corrections and sell-offs are not the times to move to cash but are actually opportunities for many investors, particularly if you are young and still contributing to the market.
For most investors who have long term investment horizons, corrections are good because it means when you’re averaging in, as you do via super, you’re buying in at a lower level.
Looking for opportunity
During a sell-off, investors tend to sell things willy nilly. The trick for investors through these periods is to try and find value rather than to get too hung up on the fact that the market is coming down.
Back in 2008, at the height of the GFC, famous US investor Warren Buffett, who was buying beaten-up financial stocks like Goldman Sachs, said he didn’t know when the markets would bottom. But what he did say is that the companies he was investing in will most likely be around in the years ahead and that the US economy would recover.
In the current correction, it’s wise to take that approach. Instead of focussing on a short-term, day-to-day horizon and leaving all your funds in cash, have the confidence to focus on the long-term trend, and to look for opportunities the correction has created.
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