Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 212

Decide if 'fake crises' are worth the worry

'Fake news' has been dominating the media since the Trump Presidential win. Financial markets have a parallel concept we will call 'fake crises'.

A fake crisis is a major sell-off of one or more asset classes brought on by widely-held expectations of an impending disaster, but one that fails to eventuate or has been massively exaggerated.

Unnecessary losses from a fake crisis

A fake crisis can inflict heavy losses on an investor who dumps quality assets at depressed prices during the panic but provides the opportunity for an investor to acquire good assets cheaply.

An outstanding example of a fake crisis in investment markets – the cause célèbre – occurred in the early weeks of 2016. The dominant view then was China’s economy was 'contracting' and would soon cause a global recession. Commodity prices, share markets and the Australian dollar plunged.

As things turned out, retail sales continued at almost double-digit growth, industrial production expanded strongly, and China boosted demand on a scale the doomsayers had not allowed for. Shares, commodities, confidence and the Australian dollar all rebounded.

Other fake crises in investment markets during recent years

Many examples of fake crises have unnecessarily worried investors, including:

  • The initial (but very brief) collapse in share prices following Donald Trump’s win in the US presidential election.
  • The loss in market sentiment following the Brexit vote in June 2016.
  • The 'taper tantrum' in 2013, when bond markets sold off aggressively on the expectation the Fed would mismanage the phasing out of its huge programme of bond purchases.
  • The 'sovereign debt crises' in Europe in 2012 and 2013, which were exaggerated and were followed by record low bond yields.
  • The widely held fears in the second half of 2011 that the US economy was sliding back into recession.

Fake crises generally follow the same pattern. Investors always have a lot of things to watch and to worry about. From time to time, concerns develop, sometimes without justification. A momentum builds up. Many investors come to uncritically accept data or comments that support the majority view while ignoring the countervailing facts. Maybe some hedge funds will 'short' assets or asset classes, expecting to buy them back during the crunch at lower prices. Research reports may be released full of gloom and doom to support the portfolio positions the hedge funds have taken up.

Managing reactions to a fake crisis

The best way I know of working out whether a crisis will create prolonged pain or be short-lived is for the investor (perhaps through his or her adviser) to create two lists on the outlook for the relevant market or markets. One list would show the worries. The other list would set out the positive or counter-balancing influences. The investor can then take an on-balance view appropriate to their risk tolerance.

This approach can be applied to any or all investment markets. Let us try it on the current outlook for the Chinese economy.

List of China negatives and positives

Negatives:

  • The huge build-up in indebtedness by Chinese governments (at the national and regional levels) and by property developers.
  • The potential for bad debts of banks to blow out.
  • The excess capacity in heavy industry.
  • The risk of a surge in capital outflow causing a run on the Renminbi.
  • The slow pace of reform among state-owned enterprises.

Positives:

  • China has a high level of saving.
  • The increased debts are mostly owed domestically and not to lenders abroad.
  • International reserves still stand at US$3 trillion.
  • For many years there will be a high level of building construction for the urbanisation program.
  • To date, the move to a more market-determined exchange rate mechanism is working well.

Buy, sell, do nothing?

A reasonable on-balance assessment is that the pace of expansion in the Chinese economy will slow a little, both cyclically and in trend terms, in the next couple of years. The risks of recession are low but there will be recurring big swings in investors’ confidence in China’s economic conditions and prospects.

China’s growth has moderated from a rate of 14% in 2007 to 7% in 2016. But in absolute terms, the year-by-year expansion in the Chinese economy has remained impressively large, and that is what matters for both global growth and the Australian economy.

Fake crises can materially impact investor returns if it leads to panic selling, so a calmer and more systematic approach is called for to avoid overreacting to the noise.

 

Don Stammer has been investing for over 50 years, including long periods with Deutsche Bank and ING. He writes a fortnightly column on investments for The Australian and has advisory roles with Altius Asset Management and Stanford Brown Financial Advisers.

RELATED ARTICLES

Lessons from a century of virus plagues

COVID-19 and the madness of crowds

What does the 'fear gauge' VIX really mean?

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Three ways index investing masks extra risk

There are thousands of different indexes, and they are not all diversified and broadly-based. Watch for concentration risk in sectors and companies, and know the underlying assets in case liquidity is needed.

Investment strategies

Will 2022 be the year for quality companies?

It is easy to feel like an investing genius over the last 10 years, with most asset classes making wonderful gains. But if there's a setback, companies like Reece, ARB, Cochlear, REA Group and CSL will recover best.

Shares

2022 outlook: buy a raincoat but don't put it on yet

In the 11th year of a bull market, near the end of the cycle, some type of correction is likely. Underneath is solid, healthy and underpinned by strong earnings growth, but there's less room for mistakes. 

Gold

Time to give up on gold?

In 2021, the gold price failed to sustain its strong rise since 2018, although it recovered after early losses. But where does gold sit in a world of inlfation, rising rates and a competitor like Bitcoin?

Investment strategies

Global leaders reveal surprises of 2021, challenges for 2022

In a sentence or two, global experts across many fields are asked to summarise the biggest surprise of 2021, and enduring challenges into 2022. It's a short and sweet view of the changes we are all facing.

Shares

2021 was a standout year for stockmarket listings

In 2021, sharemarket gains supported record levels of capital raisings and IPOs in Australia. The range of deals listed here shows the maturity of the local market in providing equity capital.  

Economy

Let 'er rip: how high can debt-to-GDP ratios soar?

Governments and investors have been complacent, even encouraged, the build up of debt, but somewhere, a ceiling exists. Are we near yet? Trouble is brewing, especially in the eurozone and emerging countries.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.