NOV 22 2018
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NOV 22 2018
All Posts

The decline in markets - will it be different this time?

Posted by: Aaron Drew, Economist and Rutherford Rede Investment Committee Member in finance

The decline in markets over October occurred amongst the backdrop of a laundry list of risks and uncertainties,including:

  • Rising trade tensions between the US and China and increasing evidence this is starting to matter for the world’s two largest 
  • Rising risk that the Italian government will default on its debt obligations
  • Rising risk that the UK will have a ‘hard’ Brexit
  • Uncertainty around how US interest rate normalisation will impact both its growth and global growth, with the resilience of emerging markets to capital outflows being a key concern.

Of these concerns the last is probably the most material. Some commentators have suggested that the decline in equity markets is a sign of tougher economic times ahead. Markets are ‘discounting in’ weaker growth and hence corporate earnings into today’s share prices. On their side is the fact that the US Federal Reserve, which is currently increasing interest rates, has never in the past been able to engineer a ‘soft landing’. At the end of all previous tightening cycles in the US, the US economy has had a recession (which technically means 2 quarters of negative GDP growth). 

On the other hand, the Nobel prize-winning economist Paul Samuelson is credited with saying that the “Stock Market has predicted 9 of the past 5 recessions”. This quip reflects the fact that periods of heightened market volatility are nothing new, and markets (along with everyone else) are not very good at forecasting the future. Markets can over-react to risks and uncertainties. In addition, the fall was sharpest in the tech sector, which has been over-valued compared to other parts of the market.

Which view is right? Could this time be different regarding how the US tightening cycle will end? Time will of course tell, but there are features of the economic environment this time round which really are different, notably:

  • US households and businesses have been quite cautious over the economic recovery period since the GFC. There hasn’t been a splurge in business investment, residential housing, and other large expenditure items as employment and business profitability levels have improved. Consequently, the financial position of corporates and households are not stretched, and this reduces the risk of an abrupt slowdown as rates are increased.
  • The US economy itself is less important in the global economy than what it has been in previous tightening cycles. The Chinese economy is now around as large as the US and has a large contribution to global growth given it has been growing at around twice the pace of the US economy in recent years. It is not hence inevitable that a US slowdown will cause a global recession.  

In addition to these differences is the fact that other central banks over history have been able to engineer ‘soft landings’. Our neighbour Australia is sometimes called the ‘lucky country’ because it has not had a recession since 1991, despite four tightening cycles since that date.  Maybe this time round the US economy will get lucky!

KEY FACTS FROM AROUND THE GLOBE

The global economic environment is slowing, but from a high-level and it remains strong for now. The pull back in markets is something that should be expected from time to time, and it does not necessarily herald that tough times are ahead. The New Zealand economy continues to do relatively well. Our long-term held view is that growth is not being held back by a lack of demand for our exports, or by weakness in domestic employment opportunities and household spending. Instead, performance is being held back by supply constraints in infrastructure and the construction sector. The key economic and social challenge for the Government remains the legacy of under-investment in our transport network and housing.

Events

  • Markets fell precipitously in October, having the worst month since the GFC period.
  • The Conservative Party in the UK snatched defeat from the jaws of victory. A deal between Theresa May and the EU around Brexit was rejected by senior party figures.  This raises the risk the UK will crash out of the EU in March next year.
  • A so-called ‘blue wave’ in US mid-term elections resulted in the Democrat Party taking back a clear majority in the House of Representatives.
  • The Financial Markets Authority and Reserve Bank released its report into conduct and culture in our banking system. A key recommendation was that banks need to remove all sales measures and revise sales incentives for products like insurance, Kiwisaver and wealth advice.

Economics

  • NZ CPI inflation was 1.9% in the year to September, with the quarterly data around twice as strong as the RBNZ forecast. Rising petrol prices are the main culprit for this high out turn.
  • NZ business confidence appears to have stabilised. The ANZ’s business confidence survey showed that a net 7% of firms expect their own activity to increase, compared to 8% in the previous month.
  • International economic agencies mildly downgraded their global growth forecasts for 2019 and 2020. The IMF projects global growth to be around 3.7% in 2019 - a figure that is still above the long-term global growth trend of around 3.5%.

Markets

  • Equity Markets fell sharply over the month.  Developed international equity markets fell around 6%, whilst the NZ share market fell even further at around 6.5%.  To mid-November markets have recovered around one-third of these losses.
  • The NZ dollar initially fell as markets fell, but it rallied later through the month and into November.  This is unusual from a historical perspective.
  • Motorists got some relief at the pump.  Petrol prices fell from record highs in September as international oil prices declined with the equity market turmoil, and as our currency strengthened.

KEY FIGURES

The information contained in this report are provided for general information purposes only and do not constitute financial, legal, or tax advice, or take into account any person’s particular financial situation or goals. MyFiduciary Ltd. does not assume any responsibility for giving legal or other professional advice and disclaims any liability arising from the use of the information.  If you require legal or other expert advice you should seek assistance from a professional adviser.

Tags: The World In Ten Minutes, Monthly Economic Roundup,

The decline in markets over October occurred amongst the backdrop of a laundry list of risks and uncertainties,including:

  • Rising trade tensions between the US and China and increasing evidence this is starting to matter for the world’s two largest 
  • Rising risk that the Italian government will default on its debt obligations
  • Rising risk that the UK will have a ‘hard’ Brexit
  • Uncertainty around how US interest rate normalisation will impact both its growth and global growth, with the resilience of emerging markets to capital outflows being a key concern.

Of these concerns the last is probably the most material. Some commentators have suggested that the decline in equity markets is a sign of tougher economic times ahead. Markets are ‘discounting in’ weaker growth and hence corporate earnings into today’s share prices. On their side is the fact that the US Federal Reserve, which is currently increasing interest rates, has never in the past been able to engineer a ‘soft landing’. At the end of all previous tightening cycles in the US, the US economy has had a recession (which technically means 2 quarters of negative GDP growth). 

On the other hand, the Nobel prize-winning economist Paul Samuelson is credited with saying that the “Stock Market has predicted 9 of the past 5 recessions”. This quip reflects the fact that periods of heightened market volatility are nothing new, and markets (along with everyone else) are not very good at forecasting the future. Markets can over-react to risks and uncertainties. In addition, the fall was sharpest in the tech sector, which has been over-valued compared to other parts of the market.

Which view is right? Could this time be different regarding how the US tightening cycle will end? Time will of course tell, but there are features of the economic environment this time round which really are different, notably:

  • US households and businesses have been quite cautious over the economic recovery period since the GFC. There hasn’t been a splurge in business investment, residential housing, and other large expenditure items as employment and business profitability levels have improved. Consequently, the financial position of corporates and households are not stretched, and this reduces the risk of an abrupt slowdown as rates are increased.
  • The US economy itself is less important in the global economy than what it has been in previous tightening cycles. The Chinese economy is now around as large as the US and has a large contribution to global growth given it has been growing at around twice the pace of the US economy in recent years. It is not hence inevitable that a US slowdown will cause a global recession.  

In addition to these differences is the fact that other central banks over history have been able to engineer ‘soft landings’. Our neighbour Australia is sometimes called the ‘lucky country’ because it has not had a recession since 1991, despite four tightening cycles since that date.  Maybe this time round the US economy will get lucky!

KEY FACTS FROM AROUND THE GLOBE

The global economic environment is slowing, but from a high-level and it remains strong for now. The pull back in markets is something that should be expected from time to time, and it does not necessarily herald that tough times are ahead. The New Zealand economy continues to do relatively well. Our long-term held view is that growth is not being held back by a lack of demand for our exports, or by weakness in domestic employment opportunities and household spending. Instead, performance is being held back by supply constraints in infrastructure and the construction sector. The key economic and social challenge for the Government remains the legacy of under-investment in our transport network and housing.

Events

  • Markets fell precipitously in October, having the worst month since the GFC period.
  • The Conservative Party in the UK snatched defeat from the jaws of victory. A deal between Theresa May and the EU around Brexit was rejected by senior party figures.  This raises the risk the UK will crash out of the EU in March next year.
  • A so-called ‘blue wave’ in US mid-term elections resulted in the Democrat Party taking back a clear majority in the House of Representatives.
  • The Financial Markets Authority and Reserve Bank released its report into conduct and culture in our banking system. A key recommendation was that banks need to remove all sales measures and revise sales incentives for products like insurance, Kiwisaver and wealth advice.

Economics

  • NZ CPI inflation was 1.9% in the year to September, with the quarterly data around twice as strong as the RBNZ forecast. Rising petrol prices are the main culprit for this high out turn.
  • NZ business confidence appears to have stabilised. The ANZ’s business confidence survey showed that a net 7% of firms expect their own activity to increase, compared to 8% in the previous month.
  • International economic agencies mildly downgraded their global growth forecasts for 2019 and 2020. The IMF projects global growth to be around 3.7% in 2019 - a figure that is still above the long-term global growth trend of around 3.5%.

Markets

  • Equity Markets fell sharply over the month.  Developed international equity markets fell around 6%, whilst the NZ share market fell even further at around 6.5%.  To mid-November markets have recovered around one-third of these losses.
  • The NZ dollar initially fell as markets fell, but it rallied later through the month and into November.  This is unusual from a historical perspective.
  • Motorists got some relief at the pump.  Petrol prices fell from record highs in September as international oil prices declined with the equity market turmoil, and as our currency strengthened.

KEY FIGURES

The information contained in this report are provided for general information purposes only and do not constitute financial, legal, or tax advice, or take into account any person’s particular financial situation or goals. MyFiduciary Ltd. does not assume any responsibility for giving legal or other professional advice and disclaims any liability arising from the use of the information.  If you require legal or other expert advice you should seek assistance from a professional adviser.

Tags: The World In Ten Minutes, Monthly Economic Roundup,

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