Thoughts on the recent share correction

In the last few days we have all heard the news regarding the stock market. I saw headlines with the
words ‘Bloodbath’, ‘Carnage’ & ‘Crash’ to name a few.

Of course, each headline is accompanied with statistics and facts about the size of losses and or
records broken. In fact, one of the radio stations had a news report that stated that the losses were
due to fear of a US recession but I am simply not sure how they formed this conclusion.

The stock market is falling but this is both normal and expected. The Australian stock market has
done very well in the last 6 months. In fact, the ASX 200 rose from 5,650 points on the 3 rd of October
2017 to 6,120 points on the 3 rd of February 2018 and this represents an increase of over 9% over a 4
month period. The US stock market has gone up even more and in fact went up over 7% in January
Investment markets simply don’t keep rising and pull backs are very normal. Where they become a
concern is when the markets go into free fall like what happened during the GFC but even then they
slowly recovered all of their losses.

It is important to remember that stock markets are ‘leading indicators’ and this means that their
movement is generally a reflection of where investors expect an economy to be going as opposed to
where it is now. Therefore, it is not uncommon to see stock markets go up significantly in the middle
of slow economic times simply because investors are basing their purchasing decisions on what they
perceive a company’s profit will be as opposed to what it is now (i.e. you are buying based on future
potential growth).

Shares will be sold off and markets will correct usually once investors have data that confirms both
current and likely future economic conditions. This is why stock markets sometimes fall when the
economic news seems to be good.
The US economy is not only the largest economy in the world but also the most influential. Their
unemployment rate is now very low (below that of Australia), their economy is growing and picking
up speed and for the first time in a very long time, wages are starting to increase. Lastly, they have
recently passed tax cuts and the expectation is that this will inject an added boost to their economy
in the years ahead.

So why the sell off? The US economy is now doing well and this is improving the global economy.
Maybe it is because investors are now starting to get concerned about inflation. Higher wages are
great but they do lead to higher prices. Higher prices can cause inflation and this is usually followed
by higher interest rates. Higher interest rates and higher wages then eventually result in lower
profits for companies as their borrowing costs increase as do their staffing costs.
Bond yields are now starting to increase (first sign of rising interest rates) as investors demand a
higher interest rate for longer duration bonds to combat expected future inflation. There is also the
expectation that the US federal reserve will increase interest rates maybe 4 or 5 times this year.
Therefore this sell off is likely more to do with a re-pricing of shares based on new economic data
combined with profit taking of investors who have done well over the last year. Most economists are
not predicting a recession and in fact still feel that shares will continue to move higher albeit with
some corrections as is happening now.

We have attached an article written by Shane Oliver that explains all of this in a lot more detail for
those who are interested. ( Click here for the article in PDF )

As always, we are happy to chat about this or anything else should you have any questions and or