Global share markets have been very weak over the past few days. In the past week, US shares have fallen by 11%, the Shanghai market by 21%, Australia by 4% and the NZX 50 by 2%.

 

These share market declines have been driven by three factors.

 

Firstly, increased market concerns about China’s economy, and the impact that is having in other areas that are closely connected to China – namely commodity prices, emerging markets, and the global growth outlook.

 

These concerns were triggered by a manufacturing survey for China that was released on Friday, which indicated that Chinese manufacturing activity is declining at its fastest pace since 2009.

 

At Milford, we have been concerned about China for some time, and we were not surprised by this manufacturing news. In our view, it is just symptomatic, along with the recent currency devaluation, of the overall weakness in the Chinese economy. For example, Chinese electricity consumption – a good indicator of the growth of an economy – is now shrinking, down 1.3% in the past year, compared to an average of 11% annual growth in the five years to 2013[1].

 

The second major factor is that global share markets have been on a great run for some time, so valuations were at a level where there was room to move lower.

 

The third aspect helping push markets lower has been that many investors globally have taken on extra risk on the expectation shares would continue their recent strong returns. This means that, when investors’ views change, there can be a rush of people trying to get out at the same time, hence leading to sharp moves in share prices.

 

The key question then is where to from here?

 

We are still cautious on share markets in the near term. We are not calling a bottom to markets yet – they may have further to go. We believe the Chinese economy will continue to weaken over time.

 

As a result, we remain in defence mode in our Funds.

 

For example, we have been limiting exposure to Australian commodity and energy companies, which are exposed to the Chinese economy, for several months. We have been increasing our exposure to the US dollar, which provides a cushion to weaker share markets, and we are holding more cash in our Funds.

 

On particularly weak days, these will not be enough to prevent our Funds falling, but our strategy is to use these and other elements to reduce the impact and preserve capital, where possible.

 

Importantly, it is not all bad news. There are a number of key positives to the current market situation, which taken together, mean that we do not see this as a cause for panic: 

  • Overall share market valuations are now looking much more attractive – P/E (price to earnings) ratios are the most attractive they have been for several years
  • We believe that this is nothing like the global financial crisis (GFC) six years ago. Global banks are in a much stronger position, for example
  • The US economy is still performing well
  • Share price declines are providing good opportunities in companies that are not exposed to China
  • Market weakness will mean more supportive policy from central banks and governments globally. In particular, it means interest rates will stay low, and this will support share markets.

 

As painful as the recent falls have been, investors need to be aware that short term market declines are a normal part of investing in shares. This is part of the risk that investors are taking in shares, in order to try and achieve a higher return in the medium term. Consistent with this there have been some huge swings in the NZ market over time, but if we look back to 1956 the average return in NZ shares, including dividends, has been just over 11% per annum.

 

With interest rates so low, and share valuations improving, we believe that shares will do better than interest rate products if we keep focused on our company selection, and on that medium term, multiple year investment horizon.

 

David Lewis

Portfolio Manager

[1] China National Energy Administration

Disclaimer: This blog is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.