Shares: Down but Not Out

Shares: Down but Not Out

Most investors are familiar with Warren Buffett’s advice to be fearful when others are greedy and greedy when others are fearful. But when share prices fall around the globe as they have in recent weeks, it’s difficult to keep your wits about you when everyone else is at their wit’s end.

At a time when it’s difficult to forecast what will happen to share prices from one week to the next, what is certain is that investors who focus on value rather than price will be the first to find disregarded gems among the debris.

Before jumping in though, it’s important to understand the reasons behind the biggest market volatility of the year.

What Just Happened?

The trigger for the biggest sell-off this year was the Chinese market’s 8.5% fall on in late August. Shares on global markets quickly followed suit. By the end of August, the local market was 16 per cent below its April high. Although there have been worse corrections since 2008, it was the sight of so many global markets toppling in unison that had many investors rattled.

Chinese Slowdown

After climbing 150% in the year to June 12, it was clear to many observers that Chinese shares were due for a reality check. The Shanghai market has fallen about 38% from its June peak, but it’s still about 35% higher than a year ago.

The issue that pricked the Chinese share bubble was concern about a worse than feared economic slowdown as the nation transitions from an investment boom to a consumer-driven economy. The International Monetary Fund forecasts growth of 6.8% in 2015, a cracking pace compared with other leading economies, but well down from 7.4% last year.

Global Concerns

Events in China may have triggered the recent volatility, but global investors have been worried on a number of fronts all year. Falling oil and commodity prices, the Greek debt crisis, uncertainty about when the US Federal Reserve will start lifting interest rates and the recent events in France have made investors cautious.

Sharemarkets hate uncertainty and are likely to over-react to news, good and bad, until the outlook is clearer.

A Correction, Not a Crash

The general consensus among economists and commentators is that local shares are experiencing a correction, not a crash. Our sharemarket is not over-valued and the outlook for the local economy is still fundamentally sound.

According to CommSec, the US and European markets were 18-20% over-priced before the latest sell-off, the Shanghai market was 46% over-valued while Australian shares were just 10% above their long-term average price-to-earnings ratio of 15. The ASX price-to-earnings (P/E) ratio is currently sitting at 18.4x, just above its 8-year average of 18.1x. At the height of the August selloff we saw the index P/E drop just under 18.1 for only two trading days, and that was a fairly clear signal for the market to turn around from there.

In other words, local shares are not cheap but not expensive either. And some stocks that have been heavily sold may already be in value territory, provided their earnings are underpinned by solid economic fundamentals.

Australia’s economy is growing slowly but steadily. The Reserve Bank of Australia forecasts growth will rise from 2% to 2.5-3.5% by the end of 2016. Consumers are spending and property prices are rising. Even falling commodity prices are not all bad; they keep inflation low and they are driving the fall in the Aussie dollar which helps our export and tourism sectors.

Back to basics

When share prices are fluctuating wildly, it’s worth remembering that when you invest in shares you are investing in companies not abstract prices. As the annual profit reporting season draws to a close, there were few nasty surprises. Despite the challenging conditions, companies lifted dividends by about 8 per cent on average.

Australian shares offer substantial rewards for investors in quality companies who stay the course.

If you would like to discuss any of the issues raised in this article in the context of your financial situation, don’t hesitate to give us a call. Please note that this information is general advice only.  If you have any questions or comments get the conversation started on Facebook or Twitter

Sacha Loutkovsky
sacha.l@orionfg.com.au
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