It’s still too early to say we have seen the bottom in share markets. Put very simply, there are three types of significant share market falls – corrections with falls around 10%, “gummy” bear markets with falls around 20% but where the market is up a year later (like in 1998, 2011 and 2015-16) and “grizzly” bear markets, where a year after the initial 20% fall the market is down another 20% or so (like in 1973-74, the tech wreck or the GFC). A grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession does not imminent as the excesses that normally proceed recession (overinvestment, inflation surging, tight monetary policy) are not present on a significant enough scale. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls into the October lows) and it could still turn into a gummy bear market, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that has left investors nervous, the rebound from late October was not particularly convincing and many of the drivers of the October fall are yet to be resolved.

However, there were three positive developments over the last week, which help add to our conviction that we are not going into a grizzly bear market:

1. While Fed Chair Powell remains upbeat on the US economy and a December hike looks assured (for now), he is clearly aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of 8 interest rate hikes and stock market volatility and appears open to slowing the pace of interest rate hikes or pausing at some point next year. The stabilisation in core inflation around 2% seen lately may be supportive of this. Overall, he now seems a lot more balanced than in early October when referring to rates going to neutral and beyond. Fed Vice-Chair Clarida delivered a very similar message to Powell in an interview two days later, reinforcing the impression that the Fed is open to softening its stance on rates.

2. There have been more positive signs on trade. Talks between the US and China on trade have reportedly resumed “at all levels”, US Treasury Secretary Mnuchin and Chinese Vice-Premier Liu have spoken by phone, the China Daily has reported that China and the US have agreed to promote a bilateral relationship, China has sent a trade document to the US and President Trump has repeated that he is optimistic of a trade deal with China and that the US might put any further tariff increases on China on hold, if there is progress in trade talks. All this is on top of the Trump/Xi phone call a few weeks ago and suggests that there was much more to it than just a pre-midterm election publicity stunt by Trump. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet at the G20 summit at the end of the month but with Trump wanting to get re-elected, I remain of the view that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. And finally, for now at least, the US has held off on tariffs on automobiles. Of course, the market reaction to such positive developments has been relatively muted because investors are sceptical, given the failure so far this year of various US/China trade talks, but this just indicates there is all the more room for a positive response in markets, if progress is actually made.

3. While the 27% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, ultimately it has the potential to extend the economic cycle as the 2014-16 plunge did (although it’s likely to be on a much smaller scale this time). Oil prices are short term historically oversold and due for a bounce but it’s increasingly looking like slower global demand than expected is a contributor to the price plunge – along with US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil (which highlighted yet again that Trump doesn’t want to let anything damage US growth and weaken his re-election chances in 2020), rising US inventories, the rising $US, and the cutting of long oil positions. This means while oil prices are unlikely to fall for as long or as much as they did in 2014-16, when they fell 75%, they may stay lower for longer. This is bad for energy companies but maybe not as bad for shale producers, as in 2015 as they are now less geared and their break-even oil price has already been pushed down to $50/barrel or less. And it’s less of a threat to the US economy, as energy investment is much smaller than it was in 2014. It will depress headline inflation (monthly US CPI inflation could be zero in November and December) and if it stays down long enough, it could dampen core inflation. All of which may keep rates lower for longer. And it’s good news for motorists. For example, Australian petrol prices have plunged from over $1.60 a litre a few weeks ago to now falling back to around $1.30 in some cities and prices could still fall further as the oil price fall flows through to the bowser with a lag. That’s a saving in the average weekly household petrol bill of around $10.

The outlook…

Shares remain at risk of further short-term weakness, but we continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.