‘Wall of worry’ weighs on global sharemarkets

Equities market update

Litany of woes

• Every day sharemarket investors have to trawl through a raft of news and issues to understand what is driving the markets. And every day is different. Sometimes there is a mountain of factors to consider. Other days, far less. And clearly the weight shifts each day between ‘good’ and ‘bad’ news.

• Over the past few days the news flow has been markedly more ‘negative’ for stocks than ‘positive’. More like a wall of worry. And that imbalance has clearly been behind the sell-off on global sharemarkets in the past 24 hours.

• In Australia yesterday the S&P/ASX 200 index fell by 1.5 per cent. Those falls wrapped around into Europe on Tuesday. The pan-European STOXX 600 index fell by 2.2 per cent – the biggest fall in two months. The German Dax index fell by 2.1 per cent. And the declines extended into the US. The Dow Jones index fell by 569 points or 1.6 per cent after earlier being down 615 points. The S&P 500 index lost 2.0 per cent. And the Nasdaq index lost 423 points or 2.8 per cent.

• At the time of writing the ASX 200 was down a further 1.1 per cent on Wednesday.

In context

• Sharemarket declines are not necessarily always negative for investors. After a period of exceptional strength, it is helpful to have periods of correction or consolidation so that markets stay in line with so-called ‘fundamentals’ (essentially corporate profits and expectations about future profits).

• From the start of 2021 through to mid-August, global sharemarkets were broadly up by around 15 per cent, putting markets on track for annual gains of over 20 per cent. The US Dow Jones hit record highs on August 16. The ASX 200 hit record highs on August 13. In August, the Australian sharemarket racked up its 11th straight monthly gain – the longest winning streak in almost 80 years. Even with the declines so far over September, the ASX 200 is still up by 9 per cent over 2021.

• So what is behind the recent weakness and volatility on global equity markets? Many analysts attribute the declines on Tuesday to higher bond yields. That is a useful place to start, but it is useful to highlight the raft of factors at work. And note that many of these are inter-related.

• Inflation concerns.

• Rising bond yields.

• The Evergrande debt crisis in China.

• Fears that a power crisis could crimp Chinese economic growth.

• Rising oil prices (largely relates to first two issues).

• Central bank policy.

• Uncertainty over a US government shutdown and need to raise the debt ceiling.

• Covid issues: rising Delta cases; rising vaccination rates.

• Global supply chain issues.

• Sector rotation: from ‘growth’ to ‘value’.

• Geopolitics.

• Falls in iron ore prices (Australia).

• September – traditionally a softer month for sharemarkets.

Rising government bond yields

• Many analysts have ‘blamed’ rising bond yields for the latest sharemarket sell-off. But we need to focus on the ‘cause’ or reason for the lift in yields, rather than the ‘effect’. And in that respect all roads lead to Covid. Rising oil prices, supply chain effects, higher inflation, re-opening of economies and central bank policy responses all are influenced or driven by Covid.

• Over the past 18 months, central banks and governments have been putting extraordinary stimulus into their economies, supporting the consumers and businesses affected by measures like lockdowns and mobility restrictions. But rising vaccination rates have meant that economies are now reopening. And policymakers are now trying to work out the best time to start winding back some of the stimulus. (Last Thursday Norway’s central bank was the first to hike interest rates).

• A major focus of central bank responses has been the US Federal Reserve. The Fed initially started cautiously. Policymakers started to debate on when to start debating about ‘tapering’ or winding-back stimulus. The initial view was that the Covid-driven lift in inflation was temporary and that it was important not to wind back stimulus too early and threaten economic recovery.

• But the thinking has evolved. At the last Fed meeting, policymakers started to lay the groundwork for the taper to begin as early as November. And policymakers started to get more confident with their forecasts that interest rates could start rising in 2022.

• Even the rhetoric from the Fed chair, Jerome Powell, shows greater concern about the inflation threat. In testimony to the Senate on Tuesday, Powell noted: “As reopening continues, bottlenecks, hiring difficulties, and other constraints could again prove to be greater and more enduring than anticipated, posing upside risks to inflation.”

• In response to signs of higher inflation, the tighter job market and lift in economic activity, in the past two weeks US 10-year bond yields have lifted 26 basis points, from 1.28 per cent to 1.54 per cent. And 22 basis points of the increase has come in the past three days.

Economies reopen after Covid: Implications

• Of course, bond yields are still very low. And the Fed is only thinking about winding back (not removing) stimulus due to greater confidence about the economic recovery. From that perspective higher yields can be considered a ‘positive’ not a ‘negative’ development. But clearly there are risks any time that Fed policymakers change tack, and they need to be very measured in their response.

• Higher US government bond yields are being reflected in higher bond yields in other countries. And these higher yields may serve as an attraction to investors compared with investments in equity markets.

• Also higher interest rates can lead to sector rotation as well for investors. Over the past year, growth-dependent sectors like technology have been in favour. But if economies are re-opening and central banks are looking to wind back stimulus, more economically-sensitive sectors like transport, energy, travel & leisure, restaurants and services (more generally) will be favoured by investors.

• Note also that rising bond yields are broadly negative for some company valuations as they increase the ‘discount rates’ that analysts use when valuing businesses.

• CommSec has maintained a cautious view on the outlook for Aussie shares. In part this caution has been based on the expectation that corrections/consolidations were likely for global sharemarkets as economies enter the re-opening phase. We maintain this cautious stance.

• On September 1, we wrote: “After rising 24 per cent in 2020/21, the ASX 200 is still up by around 21 per cent on a year ago. While earnings over the past year have partly validated higher share prices, valuations are still high, with the price-earnings ratio at 19.61. At the same time, outlook in the ‘new Covid’ environment is still cloudy. And central banks are mulling issues like whether the recent spike in inflation is more transitory or permanent and the implications for monetary policy. While stimulus could be pared back as the economy regains its pre-delta footing, interest rates are likely to remain anchored at record low levels until 2023/24, with the investor ‘search for yield’ and attractive dividend yields of Aussie listed companies supporting share prices.

• As a result we retain our caution about the outlook for the sharemarket, expecting the ASX 200 to be in a range of 7,500-7,700 points by mid-2022. Despite our caution, if the forecast is achieved it would translate into an attractive annual gain of around 12 per cent.”

Published by Craig James, Chief Economist, CommSec