The serene sharemarket is causing unease. But investors should also relax, explains Gayle Bryant.
Much of the talk around the sharemarket lately is that it has been unusually calm. At first take, calmness may seem like a good thing, but commentators are worried – it’s not always a great state for markets.
A measure of calmness (or volatility) is shown in the VIX index, also referred to as the ‘fear gauge’. And recently the VIX has been very low.
One of the issues with a calm sharemarket, according to John Higgins, chief markets economist at research house Capital Economics, is that when people are confident about the economy they spend more, borrow more and take on more risk.
“These factors combine to build towards the next sharemarket bubble – which can sometimes lead to a crisis,” he says.
“Before the global financial crisis, for example, the VIX was trading at lows of around 12. While this doesn’t mean that the next global financial crisis is around the corner, history has shown that when fear is low there is a tendency for complacency to increase and this can create an environment where the market becomes susceptible to a sharp sell off if any surprises happen.”
UBS chief investment strategist David Cassidy says the lack of volatility in the market reflects the “macro calm”.
“Globally we have a backdrop of decent economic growth, the best we’ve seen for six or seven years,” he says. “Inflation is still low, interest rates are low and markets aren’t too concerned about the US Federal Reserve lifting rates.”
In Australia, he says, the calm has been frustrating in that markets are stuck in a narrow range and going nowhere.
“We have been something of an underperformer and lagging global markets. There is a lot of preoccupation with policy and comments coming out from Donald Trump but ultimately the macro fundamentals are looking benign,” Cassidy says.
While markets are calm, they are still rising, especially globally. “Australia is up on a one-year view but sideways on a three-month view,” Cassidy says. “The underlying trend of global markets is still up.”
Fuelling the strength in the local market over the past 12 months is the fact commodity prices have staged a comeback and the resources sector has done well. “This has led to an improvement in market earnings growth,” Cassidy explains.
“Globally, there was a bit of euphoria around Trump’s election and what he might mean to US growth. But even as this faded away the improvement in the global economy has come through and kept markets in a buoyant mood.”
Local recession fears are overblown
Cassidy advises local investors to hold more than just Australian equities. “You should be investing outside of Australia for a bigger spread of companies and more diverse exposure. Australia is very top heavy with banks and resources.”
Beyond this, he says investors shouldn’t get too caught up in any “noise”.
“I would be a buyer of any correction and if the market rallies you might think of lightening off,” he says.
While equity investors always need to think about potential downturns, Cassidy says a recession does not look imminent. “The risk over the next year is low,” he says. “In Australia’s case it has been 27 years since the last recession so we are well and truly overdue for one. But there’s no rule saying we have to have a recession.”
The greatest risk would be some type of one-off event out of left field, he says. “Geopolitical tensions could escalate,” Cassidy says. “Or there may be a correction with technology stocks, which have been very strong.”
Higgins says a big correction in the sharemarket would be most likely triggered by the onset of a recession.
“But we are not forecasting a major economic downturn in the next couple of years,” he says. “In the US market we doubt that tighter Fed policy [rising interest rates], domestic politics, overseas events or its purportedly stretched valuation will trigger a big correction in the stock market in the meantime either.”
The upshot, Higgins says, is that no bear market is being forecast in equities this year or next.
“Although we think that one is possible in 2019,” he says. “This is when tighter Fed policy is likely to be restraining demand and fiscal stimulus ought to have run its course, increasing the risk of a recession. Until then, we suspect that volatility will stay unusually low, even if it spikes from time to time.”
Gayle Bryant is a freelance financial and business journalist and sub-editor based in Sydney. She also writes for The Sydney Morning Herald and The Australian Financial Review.