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October 2018: Volatility returns to equity markets
November 16 2018 Source: Greg Newbury

October 2018: Volatility returns to equity markets

Share markets were sold down heavily across the globe in October as volatility returned to financial markets.  No single identifiable factor triggered the sell-off, although growing concerns over rising US bond yields, inflation and trade barriers between the US and China potentially contributed to the deterioration of investor sentiment. Despite this, both interest rates and commodity markets were relatively steady. We take a closer look at the key developments in October below.

Share market decline of 5-10% in most markets 

Declines in share market valuations were of a similar magnitude across most major markets. The United States S&P 500 Index declined 6.9%, with the German DB DAX falling 6.5% and the U.K.’s FTSE Index finishing 5.1% lower. Losses in Asia were greater, with China (down 8.3%), Hong Kong (down 10.1%) and Japan (down 9.1%) all recording material declines.

Moving sharply in the opposite direction, however, was Brazil where the share market rallied nearly 10% following the election of a new President, Jair Bolsonaro. In annual terms, most European and Asian markets are now in negative territory following the October sell-off. However, such has been the strength of the U.S. market rally over past months that the S&P 500 Index remains 5.3% higher than it was 12 months ago.

Australian share market declines similar to the global average

The decline on the Australian market matched that of the global average, with the S&P ASX 200 Index falling by 6.1% over October. Returns remain positive on an annual basis at 2.9%. All sectors on the local market participated in the decline – although property trusts, utilities and telecommunications showed defensive qualities with falls of 4% or less. The energy sector recorded the sharpest drop of 10.5%, which was consistent with a 10.8% decline in global oil prices over the month. Notwithstanding the pull back in oil prices, other commodity prices held up well with the RBA Commodity Price Index rising by 3.0% over the month.

Healthcare, consumer, small companies & resources sectors experienced larger declines

Despite this, resource stocks fell by 6.6%. Also posting larger than average falls were healthcare (down 7.0%) and consumer discretionary (down 8.0%). Consistent with the theme of larger falls being experienced in the ‘riskier’ growth orientated stocks, was a significant decline in the price of smaller companies. The Small Ordinaries Index finished October 9.6% lower.

A lower Australian dollar cushioned decline in some sectors

The larger than average decline in the export orientated sectors of resources and healthcare last month belied the benefit to these sectors from further depreciation in the Australian dollar. Against the $US, the $A fell U.S. 1.4 cents to finish the month at U.S. 70.9 cents. Since the end of January, the $A has now decreased some 12.2%. The fall in the $A over October helped cushion some of the decline in share market values for those Australian investors with unhedged currency positions on their global equity investments.

Interest rate differential between USA and Australia widened

Once again, the depreciation in the $A is likely to have been impacted by further widening in the interest rate differential between the United States and Australia. During October, the U.S. 10-year Government bond yield rose from 3.05% to 3.15%, with the Australian equivalent yield virtually unchanged at 2.63%. The higher U.S. yields reflect ongoing economic strength, with more evidence that the strong economy and tight labour markets are pushing inflation higher. The decision by Amazon to double the wage paid to its employees that are on the minimum wage level is indicative of the tightness in the U.S. labour market at present.

Inflationary pressures are absent in Australia

In contrast, there remains an absence of inflationary pressure in Australia as evidenced by the Consumer Price Index data for the September quarter, which saw the Australian annual inflation rate drop from 2.1% to 1.9%. This lack of inflationary pressure has enabled the Reserve Bank to maintain the overnight cash interest rate at the record low level of 1.5%. This interest rate has now been in place for 28 months, with little expectation that the rate will change in the months ahead.

Outlook and Portfolio Positioning

The correction on equity markets over October has returned share price valuations to more attractive levels, with the economic back drop still relatively strong and stable. However, the factors that are likely to have contributed to the nervousness on markets last month remain, and their ongoing presence creates elevated risks in the months ahead.

Without resolution of the US–China trade dispute, or evidence of a slowing in the upward trajectory of US inflation and interest rate increases, further bouts selling on equity markets can be expected. None-the-less, the return of volatility will create opportunities to add value. With the economic environment still supportive of company earnings growth, material equity market exposures are being maintained in our portfolios.

Please contact Greg Newbury or Thomas Heenan if you would like to know more about any of these developments.

Important Information
The following indexes are used to report asset class performance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR (composite of 50% hedged and 50% unhedged), FTSE EPRA/NAREIT Developed REITs Index Net TRI AUD Hedged, Bloomberg AusBond Composite 0 Yr Index, Barclays Global Aggregate ($A Hedged), Bloomberg AusBond Bank Bill Index, S&P ASX 300 A-REIT (Sector) TR Index AUD, S&P Global Infrastructure NR Index (AUD Hedged). Any advice provided is of a general nature and does not take into account personal circumstances.
Accru Financial Planning Pty Ltd is the holder of Australian Financial Services Licence No. 341864 issued by the Australian Securities and Investments Commission.

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