Global markets headed into correction territory this week, as a confluence of factors combined to spur sell-offs across the sphere. The selling was sparked by fears that US companies, particularly tech companies, would report weaker earnings than investors had expected. This caused a snowball effect as investors who were already spooked by issues such as the trade war, Italy’s budget and the rising bond yields pulled the trigger and sold out.
The graph below shows the returns of the S&P 500 (American stocks, black line), ASX 300 (Australian stocks, orange line) and Nikkei 225 (Japanese stocks, blue line). As we can see below, the recent sell-off wiped out a year’s worth of gains in less than a fortnight.
US markets rebounded overnight, with the S&P 500 up 1.86% after losing more than 3% the day before. This provides an insight into the degree in which human psychology feeds into markets. On Wednesday, investors were selling companies left, right and centre as they wanted to get out of the market. The next day, despite no major announcements being made, investors piled back into the same shares, illustrating how day-to-day price changes have more to do with investor sentiment than economic reality.
What Was Behind The Sell-Off?
The natural question on the mind of investors is what caused the sell-off this week. Although there are a multitude of factors at play, here are the key themes dampening investor sentiment:
- Human Psychology – Fear and greed play a large role in the decision making of most investors, meaning they are likely to overreact to market sell-offs
- Overoptimistic Expectations – Many investors have paid a price for US companies (particularly in tech) that assumes uninterrupted earnings growth and blue skies forever. The upcoming reporting season will test those assumptions
- Political Uncertainty – The US mid-term elections are fast approaching, whilst the Italian budget and complications stemming from Brexit paint a murky economic picture in Europe
- Trade Wars – The US and China have shown no signs that their differences will be reconciled in the near future, with no assurance that the next Trump tweet won’t be announcing another tariff
- Rising US Interest Rates – Fears that the Federal Reserve may be raising rates too quickly, which slows down the US economy and puts pressure on asset valuations. Rising interest rates are also strengthening the USD, putting pressure on emerging market economies
- China Slowdown – China is entering a cyclical slowdown, which will weigh down on global economic growth expectations
Finance 101 – Negative Gearing
With Kerryn Phelp’s shock victory in Wentworth over the weekend, the odds of a Labor election victory next year Shortened. Unlike other elections in recent memory, the policies of Labor and the Liberals are materially different, with Labor’s populist promise to reform negative gearing likely to ruffle some boomer feathers. But what is negative gearing?
At its core, negative gearing entails deliberately losing money on an investment property to reduce your taxable income. A property investor can claim a number of related expenses against their taxable income, ranging from interest on mortgage repayments to cleaning expenses to pest control. If these expenses are higher than the rent received from the property, the investor can claim a loss against their taxable income and reduce their tax bill.
The appeal of negative gearing is that money that would have been spent on tax is spent on the maintenance and development of an investment property. An investor negatively gearing a property is making a bet that they will be able to sell their property for a profit that exceeds the losses they’ve incurred on the property (after taking into consideration their reduced tax bill). This strategy worked wonders for investors who bought in Sydney and Melbourne in 2011, however as property prices weaken, it’s unclear whether investors who bought later in the cycle will come out in the black.
Negative gearing is particularly attractive for wealthier investors with a higher tax rate, as they avoid paying more tax than an equivalent investor with a lower tax rate would.
The current Labor policy is that future property investors would only be allowed to negatively gear newly constructed houses, with investors who are currently negatively gearing allowed to continue doing so. The intention is that future property investors will be forced to develop new homes rather than buying existing homes and pricing out buyers who want to reside in the property.
Sydney Property Goes Back To The Future
Labor’s proposed changes to negative gearing would be salt in the wounds of many property investors, as the Sydney property market continues its recent slide. Median house prices in Sydney are now at their lowest level since 2016, with the city and eastern suburbs the only region where prices have risen in the last year.
There are no signs of the slump subduing either, with auction clearance rates at their lowest levels since the GFC and homeowners accepting increasingly larger discounts on their original asking prices. Much to the delight of one young editor/prospective homeowner!
Health, Wealth & Sex
At what shapes up to be our best event yet, please join us as we hear from personal finance guru Noel Whittaker and bestselling sex therapist Bettina Arndt on the 29th of November! The evening will cover investing to intimacy and everything in between!
Friends and family are more than welcome to join our guests, who can register for the event here.
Mind Over Matter
From neologism to nanoparticles to the stunning image below, this month’s instalment of our regular retiree publication, Mind Over Matter, has it all!
If you’re not subscribed already, please ask your adviser to add you to the distribution list!
Who Am I?
Congratulations to Ben and Emma for correctly spotting the Iron Lady herself, Margaret Thatcher!
But Who Am I?
Observation of the Week
You will always this read incorrectly
Video of the Week – A Monty Python Funeral
Viewer discrection- contains profanity
Have a great weekend!
Jonathan Hoyle, CEO & Nicholas Stotz, Investment Analyst