Key dangers that led to a hefty pullback
AUSTRALIA’S share market lost almost 5 per cent of its value this week as investors followed their counterparts in the US and dumped stocks.
Analysts say shareholders were rattled by three key issues: the potential for faster rate rises in the US, the worsening China and US trade war and the threat of tougher government regulation for the big American technology companies.
Rising interest rates push up yields, or returns, on bonds — broadly IOUs issued by governments and companies — and can make such investments more attractive than shares.
The trade war with China, meanwhile, threatens the profits of US companies exporting to that market, and tougher regulations for tech companies are raising doubts about the outlook for their earings and the true value of their shares.
In a double whammy for companies and the sharemarket, higher interest rates also mean businesses are forced to pay more for their debt, reducing their profits.
The market volatility this week should not come as a surprise, according to AMP Capital chief economist Shane Oliver. The conditions that are helping win more investors over to bonds have been building for more than a month, he said.
“Although our Reserve Bank has interest rates on hold and Australia is not in a trade war with China, Australian investors worry that impacts on the US will affect the global economy and could mean less demand for our exports generally,” Dr Oliver said.
The US market is down about 7 per cent from its September high, while Australian shares have also fallen 7 per cent since their August high — a level that was still shy of the record levels hit late in 2007.
However, the American economy is growing strongly, which is the reason the US Federal Reserve has threatened to increase interest rates at a faster pace.
According to financial research house Digital Finance Analytics, tax cuts in the US have helped boost consumer spending and inflation, although demand in that nation’s housing market is slipping again.
“You could think about this as one foot on the accelerator and one foot on the brake at the same time,” Digital Finance principal Martin North said.
“The market thinks this will crimp the earnings position for many corporates and represents a higher risk — therefore lower returns.
“I think the fear index will remain elevated for some time, indicating more uncertainty ahead.”
InvestSmart strategist Evan Lucas said reality had caught up with US investors this week.
Most investors had calculated that interest rates might go up in the short term but they did not think the Fed would keep rates high in the long term, he said.
As a result, yields on twoyear US government bonds had jumped, but not so yields on benchmark 10-year bonds.
“What traders were basically saying was that we can see that rates will go up in the short term but over the decade we actually think the Fed is wrong … and rates will come down,” Mr Lucas said.
“All of that came to a head — the US bond market snapped out of its disbelief.
“Money will start getting more expensive.”