Investing when the market is volatile

CommSec CommSec

10 May 2019

Global sharemarkets have performed strongly this year.

The US S&P500 and Nasdaq indexes have hit fresh record highs and the Australian ASX200 index has risen to its highest level since 2007 in recent weeks.

Improving economic data, solid US earnings results, and growing expectations for monetary and fiscal stimulus boosted investor sentiment.   

The global economy is doing better than at the turn of the year. US and Eurozone economic (GDP) growth data beat market expectations in the March quarter after a “soft patch” in manufacturing activity.

Unemployment rates in the US and UK are below 4 per cent, at 49- and 44-year lows, respectively. Business investment in the UK has been hampered by the “Brexit” uncertainty. 

Encouragingly, Australia’s largest trading partner, China, posted a solid pick-up in economic activity in the first quarter, supported by infrastructure spending and tax cuts. While the Chinese economy has shown tentative signs of stabilisation, sluggish demand for smartphones and motor vehicles, and still-weak domestic demand have shown up in credit growth, trade and business inflation data in April. But global trade remains weak due to tariff tensions between the US and China and sluggish global growth. South Korean and Japanese exports have slumped.

Global shares had priced in a trade truce between the US and China amid expectations for a rebound in global growth in the second half of the year. However, trade tensions have resurfaced in early May with the Trump Administration accusing the Chinese leadership of reneging on key trade, intellectual property and cybersecurity "agreements". In response, the Cboe Volatility Index (or "VIX", a measure of expected US share price movements often referred to as the "fear gauge") jumped to its highest since January on May 7 - its biggest intraday gain this year. Commonwealth Bank Group economists estimate that if the US government applies a "worst case scenario" 25 per cent tariff rate on all Chinese exports to the US, the direct economic hit to Chinese GDP growth would be around 0.4 percentage points.

Trade tensions are not the only potential downside risk to the global economy. A sharp correction in sharemarkets could tighten financial conditions and pressure the tentative economic recoveries in China and the Eurozone. A "hard" or "crash" Brexit would cause pain for both the UK and continental European economies. The European parliamentary elections, German elections, and continued worries about the Italian banks and Italian debt sustainability also present uncertainty for investors.

So the second half of 2019 is likely to be characterised by further financial market volatility.

In this environment, investors have continued to seek safe haven government bonds and US dollars on growing interest rate differentials, deflation, and global growth concerns.

Our view is that global recession concerns in 2019 are overdone. Growth, however, is likely to continue to slow and be uneven.

Here's why:

  • The Chinese authorities have lowered their growth target, but will continue to pump liquidity into the financial sector to ease credit conditions.
  • And monetary policy may be eased further in China, supported by a pro-active fiscal policy (i.e. tax cuts and infrastructure spending).
  • US economic growth will potentially slow to a still-healthy 2-2.5 per cent with the strong labour market supportive of household consumption.
  • The US central bank is unlikely to increase interest rates again this year and will end the run-off of its balance sheet, which has been tightening financial conditions.
  • While US wages growth is the strongest in a decade, overall inflation remains benign, giving the policymakers room to manoeuvre.

Of course, the "wildcard" is US-China trade negotiations. If anything, a US-China trade agreement, US government policy focused on infrastructure spending and a pause in interest rates, could elongate the market and business cycle in the US, though earnings growth would be single digit.

Here in Australia, the Federal election has been and gone, but new policies and politicians bring increased uncertainty to the business sector, housing and share markets. The Reserve Bank’s interest rate outlook hinges on continued jobs and wages growth with inflation contained. But a more aggressive fiscal stimulus through increased infrastructure spending and tax cuts could be necessary to boost sluggish Aussie growth. The uncertain backdrop for consumers, given the property downturn and increased propensity to deleverage, are additional risks.

Aussie shares could benefit from a weakening AUD, a possible interest rate cut, and a boost to commodities from Chinese stimulus and supply constraints. Financial conditions remain supportive for shares with Aussie government bond yields near record lows, given Australia’s superior relative fiscal position and prized AAA credit rating. But subdued earnings growth of around 5 per cent looks likely in the second half of 2019 as the Aussie company "confession" period gets underway prior to the August company earnings reporting season. 
 

What should investors look at in a volatile market?

One of the ways that investors can tackle all this market volatility is through asset allocation and portfolio rebalancing.

For example, if you are risk-averse or approaching retirement, you may consider a conservative asset allocation designed to produce income (traditionally, this would mean a portfolio heavily weighted towards bonds and cash, rather than shares).

Alternatively, if your goals are geared toward longer-term growth, and you’re comfortable taking on more risk, you may consider a portfolio that is more heavily weighted towards shares. Selecting shares from different styles and sectors is important, as smaller companies are considered more cyclical than blue chip companies.

Discovering growth opportunities

Until the end of this cycle, investors are likely to favour quality companies that can demonstrate true earnings growth in a persistently slow-growth and low yield environment. Some investors may prefer companies that represent "good" value with valuations for growth shares considered to be rich, despite the correction last year.

If you’re looking for growth stocks, current volatility means that some companies are considered cheap or undervalued by the sharemarket. “Undervalued” means that the price per share is lower than what the estimated price should be (based on the company’s total worth).

On the CommSec website, you can search for companies that the experts believe are undervalued. Log in to your account and go to Quotes & Research > Tools > Recommendations. You can also use the CommSec Stock Screener to search for undervalued growth stocks. This is an ideal place to start your research if you’re looking for growth opportunities.

 

Keeping an eye on your portfolio

It’s generally a good idea to check your portfolio at least once a year to ensure that your asset allocation still aligns with your financial circumstances, investment goals and risk tolerance. You may want to consider rebalancing if your goals or financial circumstances have changed.

Understanding the current economic climate is another way to keep tabs on your portfolio. There might be specific triggers – like changes in government policy or geo-political uncertainty – that prompt you to reassess your portfolio. Knowing how you will respond in these situations, whether you adjust your portfolio allocation or sit tight, could help you reduce your risk over the long term.

 

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