Reasonable prospects ahead if investors can hold their nerve
Just when confidence in a stronger world economy was returning, a slowdown in Chinese manufacturing output and concerns about the impact of tapering of the US quantitative easing program have unsettled world investors.
For some time now, Asset Check has been warning investors, especially those in higher risk portfolios, to be prepared to hold their nerve and sit out market fluctuations. The past week has shown just how volatile share markets can be.
What's not clear yet is whether recent falls are part of the long-expected correction following rises in excess of 30 per cent in the US and other major overseas markets. Profit taking is always to be expected in such situations when investors and traders become concerned about future developments.
The slowdown in Chinese manufacturing production has been cushioned by growth in service industries, and the economy is still growing at a rate above 7 per cent per annum. There's greater uncertainty about the extent of the impact of tapering on the growth of the US economy.
A stronger US economy, at least in theory, should have the capacity to adjust to reduced liquidity even if interest rates rise to 3 per cent or 4 per cent per annum. The difficulty for investors is to know what will happen in the adjustment process reducing the demand for and price of shares.
To the extent that US share prices have been boosted by geared purchases, there's the potential for a correction of around 10 per cent or so. But even if this occurs, share investors will have fared very well over the past two years and be receiving competitive returns from their investments.
The Australian share market has been boosted by lower interest rates, which at this stage appear likely to remain low. As a result, even after last year's 20 per cent rise, the yields from our shares are still much higher than comparable fixed interest returns.
There's one further factor likely to underpin the performance of our share market. The latest bout of market volatility will probably strengthen the US dollar and increase the probability of further falls in our exchange rates. The lower our dollar falls, the more help the Australian economy will receive in repairing competitiveness and avoiding impact from the end of the mining boom.
Over the past week, commodity prices have held up relatively well. Just as Australian companies suffered from an over-valued dollar, which reduced the benefits of our higher terms of trade, a falling dollar will help offset the losses caused by falling export prices.
Despite renewed market volatility, investors with investment risk profiles they understand and are comfortable with still can expect reasonable returns in the year ahead. It's unlikely, however, that the spectacular returns of last year will be repeated.