Share market volatility - what to bear in mind...

Market Decline and Economic Concerns

Recent weeks have seen sharp declines in global share markets, driven by uncertainty surrounding U.S. President Trump’s policies. With market valuations already stretched, concerns about a potential recession have intensified.

It remains too early to say whether markets have bottomed out, and we continue to see a high risk of a correction exceeding 15%. However, annual returns should still be reasonable. While this downturn will impact short-term superannuation fund returns, it follows two years of strong performance.

Key Considerations for Investors

Investors should keep the following in mind:

• Market corrections are normal. While downturns may be unsettling, periodic declines help curb excessive risk-taking and contribute to long-term market stability.

• Recessions drive bear markets. In the absence of a recession, deep and prolonged market downturns are unlikely.

• Avoid panic selling. Selling after a decline locks in losses, and timing the market is difficult.

• Opportunities arise during pullbacks. Market declines provide chances to buy quality shares at lower prices.

• Shares offer income potential. Dividend yields remain attractive, particularly as interest rates decline.

• Tune out the noise. Headlines often amplify fear. Sticking to a disciplined long-term strategy is key to investment success.

Market Volatility is Nothing New

Markets are often calm, generating little attention. However, periodic downturns bring dramatic headlines such as "Billions Wiped Off Share Market" or "Biggest Share Plunge Since..." Some declines are short-lived, while others persist. While sharp falls often follow strong market gains, predicting their exact timing and severity is challenging.

Currently, markets are retreating from record highs reached just weeks ago. From peak to February lows, U.S. shares have fallen 9%, global shares 8%, and Australian shares nearly 9%. Though specific drivers vary, market cycles tend to follow familiar patterns—history may not repeat exactly, but as Mark Twain said, "It rhymes."

What’s Driving the Market Plunge?

The current downturn stems from multiple factors:

1. Stretched Valuations:

   • The strong market gains of 2023 left share prices vulnerable to bad news.

   • U.S. equities offered little risk premium over bonds, and Australian shares were in a similar position.

   • Equity risk premiums remain low despite recent market declines.

2. Speculative Exuberance in Tech Stocks:

   • The "Magnificent Seven" stocks (Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia, Tesla) drove much of the 2023 market rally.

   • Their valuations became unsustainably high, leaving them susceptible to pullbacks.

   • DeepSeek's AI advancements impacted Nvidia, and Tesla’s stock plummeted over 50% amid consumer backlash against Elon Musk.

3. Persistent U.S. Inflation and Interest Rate Expectations:

   • Sticky inflation has led to reduced expectations for Federal Reserve rate cuts.

4. Uncertainty Over Trump’s Policies:

   • Conflicting White House policy signals on tariffs, public spending cuts, and foreign relations have fueled market instability.

   • Weaker U.S. economic data has raised fears of a recession.

   • Trump and his team have acknowledged potential short-term economic pain, further unsettling markets.

5. Speculative Assets Hit Hardest:

   • Tech-heavy indices like the Nasdaq have dropped 14%.

   • Bitcoin has declined by 23%.

Market Outlook

Share markets are oversold and could see a short-term bounce. However, continued policy uncertainty and high valuations suggest a significant risk of further declines. A correction exceeding 15% remains likely before factors such as Trump’s tax cuts, deregulation, and Fed rate reductions take effect.

Investment Principles During Market Downturns

1. Corrections and Bear Markets Are Normal:

   • Short-term volatility is part of investing.

   • Rolling 12-month share returns frequently experience negative periods.

2. Recessions Are the Key Risk:

   • A deep bear market (e.g., 50%+ declines) usually requires a recession.

   • The U.S. market typically leads global trends.

   • While recession risk has risen, it is not yet inevitable. Political pressure on Trump and weakening growth could lead to policy shifts and central bank rate cuts that stabilize markets.

3. Avoid Emotional Selling:

   • Selling in a downturn turns paper losses into real losses.

   • Market timing is difficult, and many investors struggle to re-enter before full recovery.

4. Pullbacks Present Buying Opportunities:

   • Lower prices improve long-term return potential.

   • Dollar-cost averaging (gradually buying over time) is an effective strategy.

   • Superannuation contributions naturally follow this approach, continuously investing during downturns.

5. Dividends Remain Resilient:

   • Dividend payments have remained strong despite price declines.

   • Interest rate cuts should further enhance the relative appeal of dividends.

   • More than half of Australian companies increased dividends in the last reporting season.

6. Markets Bottom at Maximum Pessimism:

   • Sentiment often turns most negative just before markets rebound.

   • As Warren Buffett advises: "Be fearful when others are greedy. Be greedy when others are fearful."

7. Ignore Sensationalist Headlines:

   • Negative news tends to dominate coverage, but long-term trends matter more.

   • While a 1% market drop may be reported as "$28 billion wiped off," a 10% gain would quietly add $277 billion.

   • Focusing on long-term fundamentals rather than short-term media hype is crucial.

Final Thought: Stay the Course

During turbulent times, maintaining a disciplined approach is key. Superannuation is a long-term investment, and market fluctuations should not derail well-structured strategies. Instead of fixating on short-term noise, it’s better to stay informed, remain patient, and perhaps even enjoy the latest season of The White Lotus!

Rick Maggi, Financial Advisor Perth, Westmount Financial