14 Feb Market Volatility
You are probably aware there has been significant volatility in Global share markets over the past week. The press has abounded with headlines such as ‘U.S. shares suffer biggest point loss ever’ and this morning I heard the term ‘market crash’ for the first time. As usual we are bemused by these blatant attempts to promote hysteria. It is designed to sell ‘papers’ with no little cost to your personal comfort.
I have been reluctant to add to this conversation. To quote Mark Twain, “Better to remain silent and be thought a fool, than speak and remove all doubt”. Nevertheless, we believe we owe it to you to provide some context about recent market conditions.
The fall in U.S. stocks is indeed the largest ever in terms of points lost. Even though the Dow Jones Index is one of my least favourite measures, I will use this as an example. From a record high of 26,616, the DOW fell a total of 2,837 point to a low of 23,779 – a fall of 10.66%. this is significant, but doesn’t even make the top 20 of all time percentage losses. Since then, the market rebounded by some 6.2% and now fluctuates within these ranges. Those of you who were around at the time will recall in 1987 the DOW fell by a then record 508 points in a single day. However, this represented a fall of 22.6%. A 22.6% fall in today’s terms is equivalent to over 2,000 points.
This ‘correction’ is not unexpected. Even after the above, the Dow Jones index is over 24% higher than this time last year. Australian shares have suffered less so, but this reflects the fact they have generally underperformed compared to global indices, over the past year. The All Ordinaries is up just over 5% for the year to date. Note, these indices do not include dividends, they are merely the change in market values.
The triggers for this correction have been blamed on a number of issues. However, the key factor, we believe, is rising long term interest rates. This is not a sudden phenomena. U.S. 10 year bond rates are almost 0.5% higher than a year ago. This reflects both the reduction in Federal Reserve buying (quantitative easing) and the strength of the U.S. economy. Rising interest rates as a result of strong economic growth is, actually, a net positive. It partly reflects a higher demand for capital and a virtuous economic cycle. Nonetheless, a higher cost of capital has an impact on valuations. It has clearly taken equity markets some time to realise this, but realisation often triggers a ‘panic’ such as we have seen the past few days.
We have been suspicious of market valuations for a little while and the rise in interest rates is not unexpected. Indeed, these events may not yet be complete; the ‘correction’ may yet have some way to go. Market volatility was extraordinarily low for the last year or so. It is now reverting to long term averages – normal, if you like. We have deliberately positioned portfolios with these factors in mind. Our general exposure to rising interest rates has been below that of our peers, as has the general exposure to Global shares. This does not mean your portfolio is not affected by recent movements. Our more conservative positioning has been something of a headwind over the past year, we expect it will now be a tailwind in the context of risk adjusted returns. By and large the specific investments and managers chosen to populate your portfolio continue to do the job we expect. Nonetheless, we continue to review these investments on a regular basis.
We hope this information provides you with a sober basis for reflection. However, if you have specific concerns, we invite you to contact us and share your concerns with us.
Sincerely,
David Graham, MApp Fin CIMA® CFP® SSA™