A correction not a crisis

Volatility returned to sharemarkets around the world, catching many by surprise and causing some panic among investors not used to these sudden changes in investing fortunes.

Monday was the worst day on the highly regarded Standard & Poor's 500, in the United States, since August 2011. The Dow Jones Industrial Average fell 6.3% at one point.

The intraday trading was the largest since 2015 when markets were grappling with a looming Greek default and a collapse in Chinese share prices.

Brokers confirm markets have been shaky for the last week or two. Bond yields were continuing to rise because of increasing inflationary expectations.

The firmer wage figures in the US jobs report last week added fuel to the fire, sending the world's most watched indicator of interest rates - the 10-year US Treasury bonds - up to 2.94%. This is the highest it has been since January 2014, more than four years ago.

The pace of the rise has spooked some investors but there is more to the story than meets the eye.

New investing methods employ technology, particularly black boxes which are designed to start selling or buying at specific targets in the market. For instance, if the black boxes, or algorithms, had been set to start selling at 2%, the selling was triggered when Wall Street indices started their fall.

Buying may have started back when the markets fell about 10%, hence the start of a recovery yesterday.

However, investors do start to worry about their investments in growth companies more susceptible to rising interest rates.

Higher interest rates mean it costs more for companies to borrow money for expansion, cutting dividends to shareholders. A move to defensive stocks, which are cash rich and have no need to borrow, usually follows a market correction.

The United States markets dictate what happens in the rest of the world simply because of their sheer size. Investors in New Zealand are at the mercy of investors in countries like the US and Japan because of the size and wealth of those countries.

This time, the US markets have reacted to good news. Job and wage growth will mean a growing economy. A growing economy will mean a rise in inflation, something the US has been trying to achieve for about eight years.

The sell-off needs to be put into perspective. The recent sharemarket performance in New Zealand, but particularly in the US, has been nothing short of exceptional. The January rise in the S&P was the strongest since 1997 and came after 15 consecutive monthly rises, equalling the record streak from 1958-59.

The markets have been due for a decent correction for some time.

What will concern investors is the fate of their KiwiSaver accounts. Some of those will have taken a substantial hit. The aggressive growth funds, usually favoured by younger investors a long way from retirement, will have been hurt. However, if those investors were expecting a free ride to retirement, this is the lesson they should have already been told by their advisers. The best advice is to look through this immediate volatility because the markets will rise again. In other words, get used to this volatility.

Conservative funds will be less affected, as they favour less volatile investments.

Investors preferring to see their money in bank term deposits will soon start receiving higher rates on their investments.

Central banks around the world have been trying to generate inflation for a long time. In Japan, there has been deflation. The European Union has had negative interest rates for years. The US lending rate was close to zero before the Fed started to lift rates as the economy improved.

Contained inflation is a good thing for most economies as it encourages businesses to start investing now rather than waiting for lower interest rates or better conditions.

The latest market volatility is not the start of a credit crisis; it is a correction, nothing more.

Comments

It is the reality of robust capitalism. The 'Romance' of business risk. You must be prepared to lose your shirt, gambling. Stunned mullet? Don't moan.

 

 

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