We asked Chris Caton – Chief Economist at BT Financial Group

2016 began very poorly for share markets. In the first week, the US sharemarket had its worst week since September 2011, with the S&P500 index tumbling by 6%. One probably has to go back to the postwar period to find a worse start to the calendar year. The Australian share market fell by 5.8%. This morning (Monday 11 January), the market has gone through the lows of late-September and mid-December 2015 and is now at its lowest level since mid-2013.

As is so often the case these days, the most obvious culprit was China, although there were a few other factors involved in the selloff, including Middle East tensions and a North Korean bomb test. The Chinese share market was all over the place, and it wasn’t helped by the operation of automatic “circuit breakers”, which kick in when the market falls sharply. On Thursday, the market was open for less than half an hour! Not only do such mechanisms interfere with the market, but they can also precipitate panic selling, exactly what they are designed to offset. Indeed, the Chinese seem to have come to this conclusion, given that use of the circuit breakers has been suspended. For the week, the Shanghai Composite index fell by 10%.I have said this before: the Chinese share market is a casino. It tells us nothing about anything. But, of course, it’s not the only Chinese factor. There is also cause for concern about the economy and the currency.

At the moment, the currency may be more important than the economy. The yuan has fallen by about 7% against the US dollar since early August 2015, from 6.11 to 6.55. This has sparked fears of a trade war, and it also affects commodity prices, since Chinese demand (e.g. for oil) is likely to lessen when the yuan strengthens. Since oil and equity markets tend to be positively correlated these days, the argument goes that the weaker yuan depresses oil prices (currently at a more-than-11 year low) and hence share markets. There may be something to this directionally, but it stretches credulity to think that a 7% decline in the yuan (since early August) can be fundamentally responsible for the recent share market falls. A 7% currency move is no big deal in the scheme of things (the $A has fallen by twice as much since mid-May 2015), and much of the decline in recent weeks has been a direct result of the US dollar strengthening—hence the shift in mid-December to managing the yuan against a basket rather than against the US dollar alone. Nor does the weaker yuan reflect some sinister purpose on behalf of the Chinese authorities. China has been decreasing its stock of foreign reserves and buying its own currency, suggesting that the authorities are acting to limit the decline in the yuan. Which brings us to the Chinese economy. First, the share market movement is very unlikely to cause any economic weakness; the linkages are very small. Second, a lot of policy stimulus has been thrown at the economy. It’s true that it has slowed, and probably by more than the official figures suggest, but there is little evidence that it is on the way to a hard landing.

Market declines similar to those last week always spark concerns that something worse is about to happen. One can never rule out such a possibility but, on this occasion, what has already happened seems to me a significant over-reaction to any changes in the fundamental factors that drive markets.
On such occasions, many will repeat the mantra that “you haven’t lost anything if you don’t sell”. I disagree strongly with this. But the fact that losses have already been made is the worst possible reason to sell.

Selling makes sense if one has reason to believe that the future market’s trend is downwards. My view of the fundamentals is that this is simply not the case. Accordingly, I continue to expect 2016 to be a positive year for the Australian share market, with the ASX200 (4890 at time of writing) likely to end the year around 5500.

Chris Caton
Chief Economist

The views expressed in this article are the author’s alone. They should not be otherwise attributed. The author is not licenced to give financial advice, and nothing written here should be construed to be financial advice. 

Disclaimer and Disclosure
This publication has been prepared and issued by BT Financial Group Limited ACN 002916458. While the information contained in this document has been prepared with all reasonable care no responsibility or liability is accepted for any errors or omissions or misstatement however caused. All forecasts and estimates are based on certain assumptions which may change. If those assumptions change, our forecasts and estimates may also change.