Shares’ hiccup evokes 2004 — the trend is up, just mind the bumps
Shares have fallen in the past couple of weeks (due mainly to tightening in China, US bank regulation and sovereign risk). But it’s no cause for despair: predications are on track for a rising trend this year — albeit a bumpy ride. Indeed it’s looking like 2004 all over again.
From highs in early January, most share markets fell around 6% before climbing back up again. Chinese shares, which have been range bound since August, have fallen about 9%. (“Range bound” refers to shares trading in a price “channel” of defined highs and lows.)
The drops have been driven by:
- concerns that Chinese monetary tightening will result in a hard landing in China
- increasing US bank regulation
- continuing financial stress in Greece (even after the EU’s pledge of support)
So does this mean the recovery rally in shares and related trades is over?
“No,” according to Dr Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors.
It’s a correction, but it’s still a rising trend
Dr Oliver says the correction within a still-rising trend fits assessments that 2010 will see positive returns — they’ll just be more constrained and the ride will be bumpy.
He cites several reasons.
Further monetary tightening in China is likely, but the hard landing that investment markets fear is unlikely. Yet without this tightening, growth in China would probably head to 14%, creating excessive inflation and other imbalances, so this will cap growth at a more sustainable pace.
In fact, says Dr Oliver, China is a long way from needing “draconian tightening designed to crunch growth”. Having successfully managed its economy in the past decade, there’s no reason this time should be any different.
Yes, growth slowed more than desired in 2008, but a collapse in exports on the back of the global financial crisis (GFC) drove that. By its reaction, China showed it will not tolerate a sharp growth downturn.
Recent data is showing signs of a slowdown in the pace of growth in credit, money supply, fixed-asset investment, steel production and industrial production. All this suggests authorities won’t need to do too much to prevent the economy from overheating.
Inflation is rising, but, excluding food, it is still just 0.2% year-on-year. Dr Oliver says that overall, his views remain that growth this year in China will be 10% — still strong by anyone’s reckoning — and will provide ongoing support for global growth and commodity prices.
Uncertainty after aggressive US bank regulations
Shane Oliver says there is no doubt that US President Barack Obama’s more aggressive proposals to regulate banks have created much uncertainty for the sector. This includes limiting their size, barring them from owning hedge or private equity funds or from engaging in proprietary trading unrelated to their clients.
One view is that it’s a hasty move, designed to tap popular anti-bank sentiment after the Democrats (the Obama Administration is Democratic) lost the late Ted Kennedy’s Massachusetts Senate seat. But, says Dr Oliver, it is broadly consistent with the theme of more government involvement in the economy, post the GFC.
Despite that, the changes will take some time to be enacted — and there is a good chance the Republicans will block the restrictions on bank activities anyway.
Other countries, including Australia, are unlikely to go down this path, focusing rather on strengthening capital-adequacy needs.
Hellenic (and others’) impact too small
Dr Oliver says while Greece’s public finances are “a mess” they are not big enough to derail overall global economic recovery: Greece is just 2.6% of the Euro-area economy.
Several other countries face similar high public-debt problems: such as the USA, UK, Europe and Japan — but none is at risk of defaulting. It’s more likely these countries will make efforts to wind back debt, thus constraining growth, but not creating a major crisis.
Further, while interest rates globally are rising, the process is likely to be very gradual in key advanced countries with high levels of unemployment and low underlying inflation. The USA, Europe and Japan are a very long way from adopting aggressive, share-market-threatening interest rate levels.
Plus, profits globally are rising.
Despite some notable disappointments in the current reporting season in the USA, nearly 80% of companies that have reported have beaten profit expectations, with some 65% exceeding revenue expectations.
The Asian profit-reporting season is also proving strong. A 20-30% gain in profits this year will be the key factor underpinning the bull market continuing.
Finally, we are still in the early stage of a typical bull market cycle: valuations are still reasonable and investors are still relatively under-invested in shares.
Déjà vu — all over again
History has shown that after an initial rebound, the second year in a cyclical bull market is often tougher. The easy gains have been seen, shares become more dependent on earnings but stimulus measures begin to be unwound.
That is what we are likely to face for this year, too, so, says Dr Oliver, 2004 is a good guide.
The global “tech wreck” bear market ended in March 2003. Strong gains in share markets and other growth-oriented investments followed in early 2004 — much as we have seen since March last year.
However, in late January 2004, the US Federal Reserve (the “Fed”) signalled higher interest rates, which it started to do from June 2004, and China began monetary tightening, setting off fears of a hard landing in the Chinese economy.
Both events saw nine months of range trading in US shares and a 20% correction in Asian (ex Japan) shares from April to May 2004, on worries that global monetary tightening would be negative for emerging markets. The higher US interest rates and worries about the Asian growth outlook triggered a correction in metal prices and the Australian dollar into May-June 2004, but only resources shares underwent a correction.
Broad trends up, corrections are opportunities
However, despite US and Chinese monetary tightening causing corrections in growth-oriented investment markets in 2004, the broad trend in global shares, Asian shares, commodities, resources stocks and the Australian dollar remained up, as global and Chinese economic growth remained solid and fears of a hard landing dissipated.
Dr Oliver says the lesson from 2004 is that while the initial phase of monetary tightening can see a rougher ride for growth-oriented investments — particularly Asian shares, commodities and resources shares — the rising trend will continue (so long as there’s no hard landing). Any corrections will prove to have been buying opportunities. This is also what he expects to unfold in 2010.
He sees recent weakness in shares and other growth assets as a correction rather than a new bear market. The correction may have further to go, and 2010 will see more volatility than since March last year, but profit growth and still-low interest rates are likely to underpin further gains in shares this year.
Source: “Oliver’s Insights: Shares hit a speed bump – 2004 all over again?” by Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital Investors; Investor Glossary, “Range-bound trading”.