Equities

This week’s dramatic market sell-off prompted a number of scary headlines. While correct, they are often taken out of context.

FactSet tells me that the market capitalisation of the ASX 200 fell by $A50 billion on the 15th of August, a 2.9% decline on the previous day's close. What many of the headlines from yesterday don’t say is that the Australian equity market is still up 13.5% for the year (or +$A200 billion in market cap). This is much more remarkable given that there is meant to be a recession coming and earnings estimates at the beginning of the year were for very low single digit growth.

Not to downplay the still serious risks to the market and economic outlook, it’s worth a gentle reminder that markets are volatile; reward comes with risk.

Be sure to consider all the numbers – Intra-year decline versus calendar year returns

The first chart is an updated one from the Guide to the Markets  - Australia and shows the intra-year decline and year-to-date return. So far the close to 6% drop in the ASX 200 on a price return basis is not much worse than has been experienced in the past. Additionally, an intra-year decline of 10% or more is a much more common event over the last 25 years.

Even if the market was flat from here until the end of the year the 13% price return would be the best in 6 years. To repeat the -7% price return recorded for the 2018 calendar year the market would need to fall by more than 20%. While investors are worried about equity returns, none are, as yet, talking of a bear market.

Volatility returns to “normal”

The drop in markets in the last few days is the biggest for the year at 6.4%, and larger than the 5% pull back in early August which occurred just after the market broke through the prior high.

A 5% pull back is a pretty normal occurrence. Since 1994 the average number of 5% declines is 5 per year, last year there were five and that felt painful, so far this year we’ve had two. Even if we exclude the high number of 5% corrections in 2008 and 2009, the average is still four per year, so if we experienced another two or three 5% drops in the market until year end this would still be considered "normal".

Market declines of 5% can become 10% corrections or larger and the risks to the equity outlook are skewed downwards. However, the alarmist headlines should be seen in the context of how low volatility has been and equity markets that have rallied very hard over the earlier parts of the year. Furthermore, that these market drops are being made from high levels.

The take away is that the pick-up in volatility still represents a return to more normal levels and that investors have been spoilt with subdued volatility for a long time.

Markets are more than likely to remain this way for the rest of the year, as they are buffeted by trade winds, but fundamentally much of the economic data is still supportive of a slow growth not a no growth environment.



Comments

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Harry

True Kerry exactly right. Just let me know when the next big swing is, up or down, so I can plan my investment.....just joking.