Reality check slashes $57bn off markets

Investors wiped $57bn off the local sharemarket and the Australian dollar dived on Thursday.

Investors wiped $57bn off the local sharemarket and the Australian dollar dived on Thursday as a sobering economic outlook from the US Federal Reserve sparked a reality check on cyclical assets after central bank liquidity caused massive gains in the past three months despite the coronavirus pandemic.

Even after Fed officials indicated that the key US monetary policy rate should stay near zero through 2022, and that the Fed will keep buying US debt “at least at the current pace” of $US4bn ($5.8bn) per day “over coming months”, Australian shares and the dollar suffered their biggest falls in six weeks. The rout came as money flowed to the US dollar and government bonds after Fed chair Jerome Powell cautioned that “it’s a long road” to recovery and “there’s a risk of longer-lasting damage to the economy”.

In its first fall in almost two weeks, the benchmark S&P/ASX 200 share index fell 187.8 points, or 3.1 per cent, to 5960.6 points — led by economically sensitive stocks in the energy, financials, consumer discretionary, industrials and property sectors. The banks index fell 5.3 per cent after rising 30 per cent in two weeks. Healthcare, communications, uti­lities and gold miners outperformed.

Travel stocks were among the worst performers, with Flight Centre plunging 10.4 per cent and Webjet shedding 10.11 per cent, while Unibail-Rodamco-Westfield slumped 9.8 per cent.

“We finally had that much-needed down-day — but it was certainly more brutal than anyone would have expected,” said Bell Potter head of institutional sales and trading Richard Coppleson.

The S&P/ASX 200 had bounced 41 per cent from a seven-year low of 4402.5 on March 23 to a three-month high of 6198.6 on June 9. The recent bull market has been the fastest on record.

Similarly, in the currency market, the Aussie dollar tumbled as much as 2.2 per cent to US69.06c after hitting a fresh 11-month high of US70.63c following the Fed’s policy statement early on Thursday.

The Aussie dollar had risen 28 per cent from an 18-year low of US55.05c three months ago as the US dollar tumbled, while central banks supplied a deluge of US dollars to calm global markets.

In commodity markets, London Metal Exchange copper futures opened down 1.3 per cent, West Texas crude oil futures fell 4.4 per cent to US37.87 a barrel, and spot gold dipped 0.7 per cent to $US1727.29 per ounce as the US dollar index rose as much as 0.6 per cent.

Australia’s 10-year bond yield dropped as much as 10 basis points to a six-day low of 0.916 per cent.

The sell-off in cyclical assets came amid evidence of a second wave of coronavirus infections in Texas and Florida, as Australia confirmed a Black Lives Matter protester had the virus, and China doubled down on its recent warning to Chinese tourists and students against travelling to Australia.

“Selling hit almost immediately at 11.30am — straight after reports are that a protester in Melbourne has tested positive to coronavirus,” said Bell Potter’s Mr Coppleson.

“So there will be a period of uncertainty to see if others get ­infected.”

He added that speculators were wary of the potential for a further pullback in risk assets in the event that many new cases were announced over the weekend, particularly with more protests planned.

“If so, it will be an ugly Monday, so for some hot money (investors) they needed to get out and go to the sidelines until Monday and see what, if anything, comes of this.

“But in reality, quite simply, the rally was exhausted and some short-term profit-taking was needed — this was just the excuse they needed.”

The 12-month forward price-to-earnings ratio of the Australian sharemarket hit a record high near 20 times on Monday and its dividend yield hit a record low near 3.3 per cent.

The forward PE ratio of the S&P 500 hit its highest since the TMT bubble of the early 2000s.

On Thursday Japan’s Nikkei 225 index fell 2.8 per cent, the Hang Seng index fell 2.3 per cent, China’s Shanghai Composite lost 0.8 per cent, Taiwan’s TAIEX fell 1.6 per cent and Korea’s KOSPI declined 0.9 per cent.

In early European trading the FTSE 100 fell 2.3 per cent, Germany’s DAX lost 2.6 per cent, France’s CAC 50 fell 2.6 per cent, Italy’s FTSE MIB lost 2.8 per cent and Spain’s IBEX 35 lost 3.1 per cent.

Despite a much stronger than expected US jobs report for May, the Fed “seemed concerned about downside risks, and quite uncertain”, said Credit Suisse macro strategist Damien Boey.

Fed officials didn’t mention any “green shoots” of recovery despite reopening efforts, and their downwardly revised forecasts for economic growth and unemployment covered extremely wide ranges — but there was a disproportionately small dispersion in their forecasts for inflation. Mr Boey also noted that Fed chair Powell said the Fed is “not even thinking” about rate hikes, and that there would be significant costs to job seekers should asset price bubbles burst.

“Markets have moved so much in a short space of time, that for all of our concerns about inflation, negative term risk premia and the expensiveness of bonds, the reality is that equity risk premia have become even more negative than bond risk premia,” Mr Boey cautioned.

In his view, equities have become even more vulnerable than bonds to inflation risks and shifts in policy settings, and major asset classes have become “vulnerable to a sell-off together”.

“Therefore, either way the Fed chose to go, there were always going to be downside risks to contend with, with the only upside being from a strong domestic growth recovery to temporarily distract equity market investors from extreme valuations, or reflation in emerging markets,” he said.

“Looking forward, we take a view consistent with the upward-sloping short end of the VIX (S&P 500 volatility index) futures curve — that the Fed is juggling too many balls in the air.”

Mr Boey said he was therefore leaning towards quality and away from value in equities.

“We are also becoming less negative on defensive momentum and therefore less concerned about crowding, especially given that momentum factors have badly underperformed in early June.”