The Fragility of Markets

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It’s been a wild and unpredictable ride in share markets in recent months. From mid-February to mid-March we saw a massive sell-off of shares that led to price decline of about 30% internationally. Since then, markets have steadily risen to almost pre-COVID levels. However, in recent days, concerns about rising unemployment and COVID case numbers jolted the markets with another 5% or so price fall. This was a wake-up call for those investors who have becoming increasingly less risk averse in recent times, buoyed on by the rising trend and the stimulus measures that continue to be announced around the world.

There are two key factors that determine share prices – the expectations of investors and the earnings performance of companies. When these two factors are not aligned, there is potential for volatility. When investors perceptions of future earnings performance are optimistic while actual performance is on a downward trend, there is divergence between expectation and reality and markets become increasingly fragile. This means that an adverse event, such as a second wave of COVID or an announcement of higher than expected job losses, can see markets tumble as investors lose their confidence.

The risk of such adverse events is real. The US is struggling to keep COVID case numbers under control. Company closures are on the rise, and will have a ripple effect throughout economies, triggering further closures as businesses default and as spending drops in the wake of increased unemployment. Other key risks include political tension between the US and China, and the impact of COVID on global supply chains. Social tension is also on the rise due to the inequalities between those who have jobs and those who don’t, combined with travel and other restrictions which are disrupting families.

This is a time for investors to be cautious.

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