Market Update - Correction or Crisis? August 2015

At volatile times we don't usually hear from our clients as you know what to expect from your investments. We have however put together an alert for you to provide context. 

Unified Financial Services Investment Philosophy

A reminder... Our investment philosophy at Unified Financial Services is to not have you exposed to undue risk by chasing higher returns. Capital preservation is paramount.  If your long term cashflow modelling shows that your capital will not run down prematurely and that it can support your lifestyle then we modify your sharemarket exposure accordingly.

For our clients who are not in retirement mode, this recent bout of expected volatility will represent buying opportunities either personally (keep going with your salary sacrificing, keep going with directing surplus savings to the markets) or through your Fund Managers repositioning their portfolios. There is no need, especially if you have time in the markets to sell out.

For our clients who are retirees, at your Annual Planning Meeting we have already adjusted your portfolios and remember your pension payments are sourced through the cash component of your Super (up to 3 years in some cases anticipating market volatility), so no assets are sold that would crystalise losses.

There are some of our clients who are in the process of undertaking recontribution strategies - taking money out of super (the markets) and buying back in - if this is you - this represents an exciting time as you are buying back investments more cheaply.

It has been tempting in current market conditions with interest rates being so low, to look for alternative higher yielding investments such as shares and to adopt a higher level of risk without being fully informed. 

Yet again, volatile times shows the need to access good financial advice and follow a disciplined methodology of investing.

The following information which we support has been sourced from Goldman Sachs Asset Management and Centrepoint Alliance Research:-  

What’s happened?

Markets have had quite a tough time in August, and as always trying to forecast how they will act and which direction they will take is difficult. One thing we do know is that financial markets are volatile which is often brought on by irrational behaviour. Market efficiency tends to get thrown aside as irrational investor behaviour usually overwhelms rational market behaviour. The recent sell-off we believe is just that. The markets correcting due to a period of strong growth. It was expected. What followed was the irrational behaviour of investors that began to indiscriminately sell as a result. We all need to take a deep breath and realise that short-term market noise is not a reason to panic. Volatility is expected and should not be the cause of mass selling or hasty decisions.

The recent global market selloff has pushed major equity indexes into correction territory, defined as a drop of 10% or greater from recent highs. We continue to believe global economic fundamentals are strong, even as markets appear to be repricing risk. Moments such as these can, in our view, demonstrate the merits of well-diversified portfolios.

Global markets have been routed over the past two trading days experiencing falls not seen since the depth of the global financial crisis in 2008. Amid one of the worst sell-offs since 2008, global markets experienced falls of up to 8-9% as panic selling gripped the world taking no prisoners. The rout pushed the S&P 500’s two-day bludgeoning to 7%, while the world’s second largest economy, China, saw its sharemarket sink 8.5%, the most since 2007. The Australian market itself suffered its worst day yesterday as the S&P/ASX 200 Index fell 4.1%, its largest fall since the GFC.

Why has this happened?

Some have labelled what has happened over the past two days “the perfect storm”, the correction we had to have, while others have interpreted this as perhaps the start of another financial crisis. The epicentre of recent events however has been agreed upon. China and the faster than anticipated slow-down in economic growth. The propping up of the Chinese sharemarket by the government did not come this time and coupled with the devaluing of its currency, which many perceived to be a policy measure in response to slack economic growth, set the ball rolling. However, there’s been a number of other factors which have contributed. The fear of rising US interest rates and continuing doubts over the recovery of the Eurozone have also underscored the recent sell-off. Let’s get back to China. Don’t forget the Chinese sharemarket, the Shanghai Shenzhen CSI 300 Index, has grown by approximately 108% over the past 12 months fuelled by a retail stock buying frenzy. Chinese investors continued to borrow money to access the markets pushing up valuations to levels not supported by fundamentals. As news filtered through that the economy was slowing, panic set it and the sell-off begun. Most global markets were also at pre-GFC levels as investors pushed the price up on growth assets as bond yields hit all-time lows. A pull-back was inevitable.

What can we expect?

We continue to view the risk of a US recession as extremely low. The US economy expanded at a 2.3% rate in the second quarter. Full-year forecasts call for US economic growth of more than 2%.* Meanwhile, although there are signs of a slowdown in the Chinese economy and the broader emerging markets, data in Europe point to a modest acceleration in growth. When compared to headline events, we view these trends as the more significant factors, which should drive long-term market performance.

The recent selloff is, in our view, a reaction to China's market volatility and currency devaluation (amid struggles for emerging markets more generally), oil prices' drop to multi-year lows, and worries of potential Federal Reserve (Fed) interest rate increases.

Confidence levels have taken a hit in recent days and investors will remain fearful and cautious as they wait on further news out of China. It must also be remembered that China is a maturing market. Growth tends to slow as markets mature so expectations must be tempered. This would no doubt alleviate the potential of disappointment due to overly optimistic growth projections.

Regarding potential rate increases in the US, we believe recent events may make the Fed less likely to take action in the coming weeks. We believe that none of these factors are likely to derail the long-term global economic expansion. At the same time, market catalysts such as these are unlikely to disappear, which we believe underscores the importance of what we call “situational awareness” - the need to be risk–aware and strategically allocated.

We believe sharemarket volatility will continue in the short-term and whilst uncomfortable we ask you, our clients, to be prepared to exercise patience. The S&P 500 had gone more than 1,300 days without a 10% correction, a streak that spanned nearly four years. We view recent events as a reminder that localized pressures can cascade into global markets in ways which have been rare during the last few years' below-average volatility levels.

What affect will it have on Australia?

Our sharemarket, although suffering, remains fundamentally sound. We are a commodity driven economy and our fortunes as a result are closely correlated with those of China. We will feel the pain as we slowly move to a non-mining driven economy however we do have the luxury of being one of the few countries that can still pull the monetary policy lever. The RBA will keep a close eye on events and will perhaps consider cutting rates again to reinstall confidence if required.

From an investment/portfolio construction perspective, we again stress the importance of staying the course. Coupled with irrational selling, we believe recent events were expected as markets rallied beyond their means. “Don't lose sight of your strategy or your investment horizon.” The best approach is not to react too hastily. No knee-jerk reactions to short-term volatility and market noise. Markets will become volatile. It’s important to ensure that your investments are well diversified.