Fall in markets in October is just a small correction

The main cause of the fall in markets was due mainly to a sharp rise in long term US bond yields (long term interest rate) along with continued uncertainty surrounding US and China trade wars.

In uncertain times when markets are falling, the question often becomes is this just a small correction or is this the start of a larger fall in markets.

Despite the likelihood that the US Federal Reserve will continue to lift increase rates, with the Fed itself forecasting an increase in rates from 2.25pc to 3.50pc by 2020, we don’t see this correction being the start of a bear market. 

Our chief economist, Michael Knox, believes there are two reasons for this being the case.

Firstly, the US economy is growing too strongly. The US announced a growth rate for the third Quarter of 3.50pc.

That growth rate is 1.50pc higher than the average growth rate of the US economy. So, the US economy is far too strong and profit growth is far too good. 

The other thing we look at is US corporate credit spreads (the availability of liquidity coming into the US equity market).

You only get bear markets in the US when those spreads are well above long-term average. Right now, they are well below long-term average. We therefore believe that there is too much money supporting US equities. 

So, growth is too strong, earnings are too strong and there’s too much liquidity into the US equities market for there to be a bear market in progress.

We therefore see this as a normal correction in markets, which up until October were tracking above long term valuation levels. This correction has seen valuations come back to more acceptable levels. 

In taking a look at the Australian market, Michael believes that fair value is around 6060 points. At current levels we therefore see upside to markets from here. It is interesting that at the same time we’ve had this sell-off in stocks, we’ve had a general flight to quality. As stocks have been sold, investors have moved into government bonds, which has seen bond yields come off, which is ironic given rising bonds were the cause for the fall in markets in the first place. We have also seen a flight to the US dollar. The US dollar has gone to a new short time high relative to the Euro and the US dollar index. 

After the US midterm elections, we think there will be confidence in the US for investing abroad again. This should see a fall in the US dollar and subsequent gains on US and Australian stock markets.