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2018 has been a year full of surprises – from the brewing trade war between the US and China to the ongoing Brexit saga that is threatening to derail the EU again, as well as the European economic crisis. There was also much love for the stock market as investors focused on earnings and company announcements rather than the political risk in making investment decisions. The rise of the FAANGs (Facebook, Apple, Amazon, Netflix and Google) drove the NASDAQ and Dow Jones to record highs in the early part of the year.

In Australia as well, the ASX 200 rallied sharply to a fresh 10-year high of 6,400. This was driven mainly by strong positive sentiment on improving economic figures and the global market rallies among other factors. Domestically, we have our version of FAANG – which is WAAAX (Wisetech Global, Altium, Appen Technologies, Afterpay and Xero). The WAAAX gave more prominence to tech-related stocks on the ASX in recent years as they make a more prominent impact on our day-to-day activities. The tech sector is still a small component of the ASX 200; however, as the banks continue to suffer due to fallout from the Royal Commission as well as the slowing property market, many analysts are starting to pay more attention to the tech stocks listed on the ASX.

In the third quarter of the year, we have seen a lot more risk in the market that resulted in increased volatility. It was a perfect combination of stretched valuations from the recent rally, the increase in interests rates by the US Federal Reserve, the increase in the US 10-year bond yield, increasing tensions stemming from the trade war, the US mid-term election factor and more recently the collapse in oil prices.

The VIX index which is an indicator of volatility in markets rose rapidly in October due to the factors mentioned above. The index which has been around 12-18 for most of the year, broke past 20 in October, reaching a high of 25.23.

It is worth noting from the graph below that a substantial intra-year decline or correction does not mean an overall bad year. As can be seen, we have experienced prolonged periods of strong growth in the market. The analyst world is divided in half on where markets will head from here, some arguing that we may be at the end of the bull run while some claiming that we might be at the start of the bull run cycle.

The graph shows that most years in the last 25 have had intra-year corrections of 10% or more (only six years in the previous 25 have had the most significant corrections of the year under 10%), but this does not indicate a negative year overall. The size of the most significant correction in each year does not correlate with the end of year growth. 19 of the last 25 years have had a downturn of double digits and 19 of the previous 25 years have ended with positive growth.

Where to from here?

We are cautiously monitoring the market on a daily basis. What is important is that we understand the strategy adopted – which is the active management of investments in companies that have good management, good cash flow, excellent balance sheets and a good pipeline of projects. The political risk (with Donald Trump in power as well as the looming elections in Australia), macroeconomic risk factors (rising rates in the US) will continue to persist in the medium term, also contributing to ongoing volatility.

Source: JP Morgan Asset Management

Madison Financial Group Pty Ltd
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