Shares slide on growth concerns

Sharemarket trends; Reserve Bank speech

• Global sharemarkets fall: Shares in the US and Europe slid by around 2-4 per cent on Wednesday.
• Speech from Reserve Bank official: Reserve Bank Assistant Governor Luci Ellis delivered a speech: “Supporting Growth in the Short Run and the Long Run”.

 Global shares: What happened and what does it mean?

• Sharemarkets across Europe and the US fell sharply on Wednesday. There were basically two catalysts. The first was the concern that rising US longer-term rates could lead to slower US and global economic growth. The second issue was the ongoing concern that the US-China trade frictions could develop into a more significant and protracted trade war. At the heart of both issues is a concern about the potential for slower economic growth, and therefore slower sales and profit growth.
• In Europe, the pan-European STOXX600 index fell by 1.6 per cent to the lowest levels since April 4. Fears of slower Chinese demand led to a fall in luxury stocks with LVMH down 7.1 per cent after reporting softer sales. The tech sector was amongst the worst performers, down by 4.3 per cent. The German Dax index dropped 2.2 per cent and the UK FTSE index lost 1.3 per cent. In London trade, shares of Rio Tinto fell by 3.9 per cent and BHP was lower by 4.1 per cent.
• US sharemarkets fell on Wednesday as investors feared that higher longer-term bond yields could crimp economic activity and profits. Technology stocks led the declines with luxury retailers. There were also on-going concerns about the US-China trade stoush. The Dow Jones fell by 832 points or 3.2 per cent. A week earlier the Dow was at record highs. The S&P500 index lost 3.3 per cent and the Nasdaq index lost 316 points or 4.1 per cent.
• There were no direct ‘catalysts’ as such for the sharp falls on global sharemarkets on Wednesday. Rather there has been an accumulation of factors over the past week, many relating to the strength of the US economy. Last week US 10-year bond yields lifted from 3.07 per cent to a 7-year high of 3.24 per cent on concern that the strong US economy may lead to higher inflation. On Friday, data showed that the US jobless rate had fallen to a 48-year low of 3.7 per cent.
• Worries that the Sino-US trade stoush could develop into a more significant trade war have abounded for a number of weeks. But there has been no real ‘news’ on the topic in recent days. The US and China are respectively number 1 and number 2 in the global economy. And if a tariff war led to slower growth and higher inflation in the two economies, the effects would be felt across the globe.
• On Tuesday the International Monetary Fund (IMF) cut its forecasts for global economic growth in 2018 and 2019 from 3.9 per cent to 3.7 per cent. The IMF attributed the forecast changes to the US-China trade dispute as well as the fact that a number of global economies were operating near full capacity, including the US.
• It is important to highlight that the US Dow Jones index hit record highs a week ago with the Nasdaq at peak levels a month ago. So the sharp falls on Wednesday were from significant highs. Also it is important to note that the third-quarter earnings reports start on Friday with a number of banks to issue results. Some investors are no doubt positioning ahead of the reports.

Reserve Bank speech: “Supporting Growth in the Short Run and the Long Run”

• Reserve Bank Assistant Governor, Luci Ellis, basically focused on how fiscal and monetary policy have supported the Australian economy over the past decade – a decade dominated by the mining boom and subsequent downturn. Ms Ellis noted that a key question for policymakers is when to change settings.
• “While there is spare capacity remaining, it is important for policy to support above-trend growth and work that spare capacity down. This raises the question of what trend might be and how we would know. Just waiting until you see wages growth or inflation pick up would leave policymakers in the dark about how quickly they are moving towards their goals, or even if they are doing so at all.”
• Ms Ellis said one indicator to watch was employment. “If employment is growing faster than the working-age population, and the unemployment rate is coming down, those are pretty good signs that the economy is running faster than ‘trend’.”
• Ms Ellis noted that there were issues for policymakers in running expansionary policy for a number of years (“unintended consequences”) including the impact on asset prices, financial stability and distributional effects.
• One ‘take-away’ from the speech is that the Reserve Bank will be closely dissecting a range of indicators in coming months to find the ‘right’ time to start removing policy accommodation.

What are the implications for investors?

• There are a number of challenges for both investors and policymakers. But there always are. The US Federal Reserve will try and avoid policy mistakes in determining the timing of rate hikes and the level of interest rates. Investors need to ascertain whether their portfolios are positioned appropriately for the economic times.
• While the Australian sharemarket is under-performing US sharemarkets, it is out-performing the Morgan Stanley Capital International (MSCI) Asia Pacific index (ex Japan).
• We see the potential for one further US rate hike in 2019 with two further hikes in 2019. Analysts largely assume that the US Federal Reserve will “pause” in its rate hiking path when the federal funds rate is near 3 per cent.
• Investors must make a judgement whether recent sharemarket declines represent the “pause that refreshes”, and therefore maintain exposure to growth-focused stocks and sectors.
• US sharemarkets are arguably relatively expensive at present. But if company earnings results over the next month are solid, they would serve to validate current valuations.
• The US economy is operating at or near “full capacity” but inflation is contained. There are greater risks for policymakers in the current environment.
• Determining how the US-China trade dispute will be resolved is difficult. Chinese authorities may decide to wait until after mid-term US elections in November before deciding the next move.
• CommSec doesn’t expect a change in interest rates until 2019. But it will be important to watch job figures, wages and prices to try and glean when the Reserve Bank will come off the interest rate sidelines.