Hide your honeymoon pots – we’re in what financial commentators call a “bear market”.
But what is a bear market? Like its namesake, a bear market can be quite scary, especially for investors. It is when the value of stocks falls over a long period of time in the general market.
For investors, this could mean that a stock they bought for, say, $100 is now worth $50. This means a considerable loss if they have invested a lot in this stock. The Nasdaq composite – a US stock index representing thousands of companies – the Dow Jones and the S&P 500 have all posted heavy losses in the past three months.
In Australia, the ASX 200 – a stock market that tracks Australia’s 200 largest listed companies – is also down.
Although it is not yet a financial crisis, the mood is undoubtedly gloomy. But on the other hand, does a decline in stock prices offer a silver lining for new investors?
In Australia, some might see buying shares as an attractive investment opportunity, especially when it may seem like real estate investing is out of reach for many. And when it looks like short-term low-priced stocks might rise, a future sell-off could be seen as an alternative investment in financial security.
But is this really an accurate way of thinking – and what are the main risks when beginners try to enter the market without a clear investment strategy?
Professor Jerry Parwada of UNSW Business Schoolan expert in investments, financial markets and how they work, explains what is happening in the markets and what you need to take into account before you start buying it now.
Why have the markets plunged recently?
Professor Parwada: The market has recently been characterized by both increased volatility and a decline. Year-to-date, the ASX 200 has fallen 12%.
Admittedly, the long upward trend in equity prices or the “bull run” in asset prices has been interrupted by the recent decisions of the Board of Directors of the Reserve Bank of Australia (RBA) to begin raising interest rates. interest from historically low levels. they had sunk – something Australia has carried for much longer than most other industrialized economies.
Markets with interest-priced assets such as bonds and term deposits with banks become more attractive when interest rates rise because, in general, an increase in interest rates is inversely proportional to the value of fixed income assets, making these assets relatively cheaper and more attractive.
The laws of supply and demand make stocks relatively less attractive.
Why didn’t investors see this market volatility coming?
Professor Parwada: If market investors had taken into account this drop in demand and the value of stocks at the time, they could have priced in the effects of interest rate hikes on future asset prices as inflation rose. in the rest of the world.
But the volatility we see is driven by the element of surprise – the RBA had long promised that interest rates would only start to rise in 2024. This happened earlier, and the consequence is a increased volatility and even a likely sustained decline.
Are Australian markets less impacted than other countries?
Professor Parwada: It is not possible to directly compare Australia with other markets due to the timing of our move towards higher interest rates. Australia has lagged behind comparable economies such as the UK and the US.
It should be noted, however, that other markets (such as the United States) have experienced more pronounced declines in stock valuations.
Indeed, the main signal of impending interest rate hikes – inflation – began to rise in countries like the UK and the US long before and at a much faster rate than Australia. . For example, while inflation in Australia over the 2020-2022 period has remained below 5%, the US and UK have surged to their current rate near double digits.
The US Federal Reserve (the Fed) has signaled in statements that there will be an interest rate hike in the near future, while the RBA has promised to hold them until at least 2024.
Is the type of dip common? What causes them?
Professor Parwada: Volatility is a common feature of stock markets. Over a long period of 20 years, for example, the ASX200 has increased by more than 9%.
But during this period, there were periods of significant declines, followed by recoveries. Examples are the 2008-2009 crisis coinciding with the Global Financial Crisis (GFC) and the significant decline in 2020 due to the onset of the COVID-19 pandemic.
There have been smaller declines, for example when the Royal Commission’s final report into misconduct in banking, pensions and financial services was published in 2019, due to falling stock prices. stocks of banks whose stocks make up a significant portion of the ASX 200 Index.
Are there any areas of the market that are particularly volatile right now?
Professor Parwada: In times of uncertainty, certain predictable behaviors of market participants usually show up in the overall performance of the stocks that make up a broad index, such as the ASX 200.
Looking at the whole of the last month of June 2022, for example, the stable performers that even recorded a positive return on average were consumer stocks: that is, stocks of companies that make products that consumers consumers are often unwilling to give up even when the cost of living increases (such as food or household products).
These are known to be “defensive stocks” that investors flock to in times of uncertainty and have a lower tolerance for risk. These stocks have less volatility and risk, but generally slow growth.
On the other hand, resource stocks – stocks of companies that produce and sell a range of commodities such as metals, oil and fertilizers – tend to be characterized by high investor sentiment during good times which decreases in times of uncertainty. This reflects natural public expectations that demand for these resources declines in times of uncertainty. Thus, resource stocks experienced more volatility and larger price losses.
However, not all stock price dynamics are linked to interest rates. Geopolitical events such as the war between Ukraine and Russia and tensions in the energy supply chain have increased the cost of energy around the world. As a result, energy stocks are the second best performers after consumer staples.
Regarding market timing, what are the risks of investing now for non-professional investors?
Professor Parwada: Conventional wisdom says that trying to time the market for individual investors is generally a losing game, especially in times of global uncertainty.
Appropriately qualified advisers will provide investment advice that matches investors’ risk appetite and sound investment choices. For people with a low appetite for risk, low transaction cost investments using vehicles that prioritize long-term results for the long-term investor can be found.
What about the benefits?
Professor Parwada: As the long-term performance of the ASX 200 illustrates, for investors with low risk appetite the returns are quite attractive, with investors often able to ‘recoup’ their initial investments.
What advice would you have for non-professionals or first-time investors?
Professor Parwada: If you are a non-professional or novice investor, you are best advised by a qualified professional such as a financial adviser.
You should indicate upfront that you are inexperienced and be prepared to discuss your risk appetite. They can then help you start your investment journey or “stock pick” for what to add to your investment portfolio.
For those who prefer not to take advice, the option is to learn about low-cost index-linked investments that don’t involve day-to-day “market timing” to buy and sell stocks.
Are there safer investments?
Professor Parwada: What constitutes a “safer” investment is a matter best assessed with full knowledge of the individual’s situation and financial goals.
Even though commentators like to make sweeping statements about investment options that claim to be suitable for everyone, it takes a qualified, non-confrontational, and ethical adviser to patiently explore these questions and help individuals invest.
One thing good advisors will look at is the income projectile – the steps they take to make a profit – of a client, as well as their projected tax status. A comprehensive assessment of these factors then provides answers as to the suitability of investments, including those that promise to use super savings.
What should new investors know?
Professor Parwada: Be prepared to learn more about market fundamentals in order to appreciate at least what determines the value of financial assets.
Armed with such knowledge, you can successfully engage in the necessary financial self-assessment that will benefit your entry into investing – whether on your own or with the help of a good advisor. And please beware of scams and trendy investment options that promise returns that are too good to be true!
Professor Jerry Parwada is a seasoned financial economist and market analyst with nearly 20 years of experience. He is a graduate of the Australian Institute of Corporate Directors and holds several governance positions in Australia and overseas. He is available for media comment at [email protected].