Prepare for a return to the 'old normal' of sharemarket volatilityby Pattrick Smellie
In the decade since the global financial crisis, investors have enjoyed a steady upward ride and very few shocks. Prepare now for the nervous return of the “old normal” – market volatility.
October 11 was the fifth-worst one-day fall ever seen on the New Zealand sharemarket.
As often happens after a big fall, traders drew breath at that point and most global benchmark indices rose a bit.
But it was a so-called “dead-cat bounce”.
Sharemarkets fell again and, by the end of the month, had lost close to 10% of their value in just 30 days.
The US Dow Jones Industrial Average fell 8.9% from its October 3 high to its October 29 low; the S&P500 global benchmark fell 9.7% between October 1 and its low for the year on October 29; Australia’s ASX200 dropped 8.2% between October 1 and its October 25 low; and the NZX50 index followed in sympathy, shedding 8.1% between October 1 and 31.
Those movements were just short of a formal “correction”, the term used when a market or an individual share falls 10% or more.
Two markets that did suffer corrections were Japan, where the Nikkei index fell 12.8%, and the Nasdaq – an American index where technology stocks both old and new trade – was down 12.2% for the month. However, note the terminology: correction, not crash.
Despite global sharemarkets having their worst month in six years, four of the six mentioned indices were higher at the end of October than they’d been a year earlier, with only Japan and Australia trailing.
It would be easy to blame trade wars, gyrating oil prices, US mid-term elections, Trump chaos, Brexit chaos or any number of other troubling global news events to help explain the October sell-off.
But the single most significant factor was as simple as this: rising American interest rates. The plunge in global interest rates since the global financial crisis (GFC) in 2008, in some cases to zero and even negative rates, was the main reason for the so-called “bull market in everything” over the past decade.
Faced with historically low returns from having money in the bank, investors and savers turned to just about anything else to improve their income. So, it’s hardly surprising that markets have got the jitters as the 10 years of government money-printing that produced those low interest rates starts to unwind.
Led by the US Federal Reserve, with the European Central Bank and Bank of Japan forming a more cautious rearguard, a move is under way to withdraw from the global economy some of the trillions of dollars of government debt issued after the GFC. The likely result? A return to more normal financial market conditions than the world has seen in the past 10 years. And one of those normalities is more financial market volatility.
“This is part of normalisation,” says Andrew Bascand, managing director at Wellington-based Harbour Asset Management. “Less excess liquidity means a return to normal volatility.
“Asset prices need to adjust to higher interest rates and equity risk premiums need to reflect normal volatility.”
A decade of growth
Recent sharemarket gyrations might look scary, but it’s useful to keep some perspective. Assuming the financial news service Bloomberg is correct, and that global stocks lost about US$10 trillion in value in October, that means the value of all stocks on issue around the world fell back to about US$90 trillion. Well, a year ago, they were worth about US$80 trillion. In other words, share values are, on the whole, still well ahead of where they were a year ago.
Yet media coverage of rising share prices is rarely as breathless as coverage of a sharp fall. “Fear sells,” says Chris Smith, general manager at CMC Markets NZ, the local outpost of a global business that caters for active investors. “Nine out of 10 newsletters would have a bearish stance because no one wants to write a newsletter that’s very positive.”
Rather than putting investors off, Smith says October’s volatility provoked a surge in trading and new accounts. “Our clients seek volatility,” and 2018 has been a good year for them, he says.
Already this year, the S&P500 index has moved up or down by more than 1% on 49 days, and moved more than 2% on 13 days, he notes. In 2017, there were just eight such movements all year. “That’s a 700% increase in volatility. Last year, the markets were technically boring, but people get used to a low-volatility market and when it swings back, it’s such a shock.”
This is one of the tricks that falling markets play on the collective psyche. The GFC, for example, was so dramatic that for many people it might as well have happened yesterday, and the world economy still feels fragile as a result. However, from a share- or property-investor’s perspective, the 10 years since the collapse of Lehman Brothers has been a long, steady and relatively uninterrupted upward march in the value of their investments. It’s sometimes described as the longest “bull market in everything” since the early years of the 20th century.
Central banks in the world’s largest economies pumped billions of dollars of new money into the financial system to prevent a global recession; the theory was that this would stimulate economic activity. However, to a far larger extent than anticipated, those funds flowed straight into shares, land, residential and commercial property and other stores of value. In the process, wealth and income inequalities, which were already widening, picked up speed.
That sense of increasingly uneven gains, despite a prolonged period of global economic growth and higher asset values, has partly fuelled the rise of Donald Trump, the Brexit vote, right-wing nationalism and a backlash against globalisation. Yet for share and property owners, it has been a bonanza.
That party is coming to an end and financial market volatility is the harbinger. It is not, however, a sign of a next, inevitable, global financial crisis.
“The volatility we’re seeing now isn’t unusual,” confirms John Carran, a senior economist at Kiwi Wealth, an offshoot of Kiwibank that manages KiwiSaver funds as well as helping private clients manage their investments.
“What was unusual was the smooth upward path of 2017 and most of 2016. In fact, since about 2009, after the GFC, things have been quite a bit smoother than they have been historically.
“We’re probably moving to a more volatile environment, moving back to the ‘old normal’.”
Nonetheless, Carran and his colleagues have been hitting the road in recent weeks to gauge clients’ state of mind after the recent bout of market disruption and remind them that this is what investing always used to be like. He says it’s been revealing to poll audiences in recent weeks about how often they think there are major market corrections.
The consensus among investors has been that a big correction comes along only every five years or so. Yet the long-term historical record shows a correction can be expected every two years, Carran says.
“Most clients are reasonably understanding about what’s happening in the markets. They realise that the very good returns they have had over the past five to 10 years or so are not something they can rely on in the future.”
But there are some who are moving to more conservative portfolio settings. “There are clients where the volatility is a bit much and they realise they should have a different mix of investments.” Bank term deposits and government and corporate bonds are popular, he says.
Smith says every serious investor has some gold in their portfolio, but they should buy only when the kiwi dollar is strong. He notes the growing popularity of commercial-property syndicates.
One thing investment advisers agree on is that there is very little point in trying to pick market turning points. “Investment requires patience,” says Carran. “Trying to time the ups and downs is usually counterproductive.”
An unsophisticated investor who looks at their investments’ performance every day will soon be driven mad with anxiety when markets are volatile. “As Warren Buffett says, if you’re a long-term investor, you want to log in once a year.”
Where global sharemarkets head from here is uncertain. In the short term, there may be the usual “Santa rally” – the trend, dating to the late 1940s, for global sharemarkets to rise in the run-up to Christmas 80% of the time.
Over the medium to long term, the question is how much will global interest rates rise and what will be the effect on the pace of global economic growth?
On November 16, US Federal Reserve vice chairman Richard Clarida declared that interest rates were now getting closer to a “neutral” level. That was interpreted as meaning US interest rates would rise more slowly than expected.
The US dollar immediately fell, stock prices rose, and in New Zealand there was speculation that the kiwi dollar, which had been falling steadily closer to US60c, could be back to more than US70c by year’s end.
The head of research at the Bank of New Zealand, Stephen Toplis, says the rise in interest rates is both a sign that the world economy is in reasonable shape and a sign that it is likely to start slowing down.
Raising interest rates, after all, is one of the ways economic momentum can be contained in the endless tension between growth rates and the potential for higher inflation to return after a prolonged absence.
“With interest rates as low as they were, that was a green light for asset appreciation across the planet,” says Toplis.
Initially, when interest rates started to rise in earnest, traders took that as a signal of global economic health and pushed share prices even higher. “But, the further conditions tighten (interest rates rise and money is taken out of the system), the closer you get to a situation where monetary conditions actually slow down activity and in turn reduce asset prices.”
That’s roughly where we are now, says Toplis, with global economic forecasters starting to reduce their growth predictions for the next two or three years ahead. “You start to see market corrections as that information is taken on board.”
But that doesn’t mean the next GFC is just around the corner. Harbour Asset’s Bascand says the signals from global markets suggest a 30% probability of a recession within the next one to two years. A recession, however, is not a crisis, but a natural part of the cycles that economies normally go through but have missed over the past 10 years. And, says Bascand, “We are not there yet.”
Both Toplis and he agree that, at some stage, there will be more global financial crises, but neither sees the seeds of one in the current climate. “Folks shouldn’t be looking for the next GFC,” Toplis says. “That was caused by a particular set of circumstances that haven’t been recreated.
“Rather than trying to find GFC indicators, we should be looking for the next big risk that could stuff us.”
Wellington software developer Grant Holdom is not overly concerned with the return of market volatility. Although the majority of his savings are tied up in KiwiSaver, Holdom enjoys investing some of his savings personally, so far mainly in shares.
“I’m in my early forties and investing for retirement so don’t need to be liquid until my mid-sixties. Between now and then there should be at least another couple of cycles.”
During the recent bout of sharemarket volatility, he’s done nothing, “neither buying nor selling”, but he’s beginning to react to rising interest rates. “Raising my cash holdings into mid-2019 is the short-term plan,” he says.
Among small-scale investors who don’t play the market, this seems to have been the norm. Bryon Burke, the head of equities for stockbroking firm Craigs Investment Partners, says there’s been no appreciable change in investor behaviour in recent weeks, with private clients tending only to react to specific company news rather than general market trends.
“Private clients in New Zealand and overseas are still on the sidelines,” says Burke. “They haven’t really been taking part. Much of the activity is being generated by professional investors taking intra-day positions.” These are investors looking to profit from fast-moving stock prices within a single trading day.
Part of the issue in New Zealand is that the NZX has a relatively small number of high-quality stocks and low daily volumes, says Burke. Sharemarkets with higher volumes of trading lend themselves better to speculative trading.
A big part of such traders’ activities also involves “short selling”, or betting on a share or index falling and profiting on the way down.
“Most investors at home have no ability to partake in any short side of the market,” says CMC’s Smith. “The only way to hedge themselves from volatility is to be in cash or fixed income.”
There does appear to be a growing group of New Zealanders re-entering investment markets on their own account, thanks to low-cost digital platforms making investment cheaper and easier than in the past.
But they are up against an army of “trading robots” – automated trading systems that react to nothing more than the mathematical algorithm that controls them. “The algos have no emotions,” says Smith. “They’re trading on charts and momentum.”
So, for investors new either to share investing or participating in offshore markets, these have been nervous times.
That is especially true of investors in online trading and investing firm Halifax NZ, which has gone into administration along with its Australian parent, Halifax Investment Services. About 4000 New Zealand accounts have reportedly been frozen pending further investigations.
Meanwhile, online start-up investment platform Sharesies, with a bit more than $30 million in funds invested and aimed very much at younger investors who can invest only small sums at a time, has been active in warning that it is “totally normal for share prices to change”.
Co-founder Sonya Williams says Sharesies “had some of its biggest days in October”, with buy orders outstripping sells, but with a jump in the numbers selling.
“There have been a few people asking: ‘what does this mean? Should I keep investing at a time like this?’” The response from the Sharesies team is to stick to the formula of continuing to invest a steady amount regularly on the basis that, historically, that approach works over the longer term.
Smith cites an old market adage that investors should “buy on down days and sell on up days” since buying a good share when the market is low leaves more room for its value to rise.
InvestNow, another DIY New Zealand investment website with about $250 million in funds deposited in its dozens of fund options, surveyed its customers after “the final quarter of 2018 put investors under real fire for the first time in years”. Although not a scientific survey, it found very little investor reaction. Some 4% of those who took part said they’d sold during the downswing, and just 1% had sold everything. “Furthermore, 70% of those surveyed said they either did nothing or carried out research as shares wobbled – right on cue with the 2017 result showing 68% of InvestNow clients would hold on if markets fell 10% in a week.”
For Hatch, a new Kiwi Wealth venture that’s experimenting with giving New Zealand investors easy access to American shares and index funds, the recent turmoil was not exactly what they’d been hoping for. “We’d intended to launch three months earlier, when the market was still rising,” says general manager Kristen Lunman. “I thought it probably wasn’t a great time.” That was especially true as the market volatility was accompanied by a fall in the value of the New Zealand dollar against the US dollar, making investment in the US more expensive.
However, the appetite among New Zealand investors to diversify out of New Zealand shares – and, according to Bryon Burke, a cooling on the Australian sharemarket in favour of US stocks – means Hatch had a reasonable first month. “My expectations were low but we ended up having a really strong month,” says Lunman. At $1.4 million, Hatch’s total funds invested are tiny, but it’s ahead of projections and funds deposited are rising daily, she says.
As a start-up where everyone does everything, they have a “pretty good pulse on our users and how they are feeling”. “They aren’t jumping for joy and are honestly expressing a bit of anxiety and surprise over the volatility, but they aren’t acting on their fears. There’s a general sentiment of hold tight.”
This article was first published in the December 8, 2018 issue of the New Zealand Listener.
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