Australian share market moves into a technical ‘correction’ as war and inflation realities hit home

The Australian share market has entered a “technical correction”.

A technical correction is a bit of financial markets jargon for a market fall, from a recent peak, of 10 per cent or more.

The S&P/ASX200 hit an all-time high of 7,628 in August 13, 2021, and a peak of 7,558 on February 3rd this year.

Today, the benchmark share index — the one that tracks a shopping list of stocks on the Australian Securities Exchange — fell 0.82 per cent to close at 6,844.

It means the index is down 10.3 per cent from its all-time high, and 9.5 per cent from its peak in February.

Indeed, the share market didn’t charge through the “correction” trigger today, it simply hovered around it — unsure of where to proceed.

Diversified energy company New Hope Corporation led today’s falls retreating 9 per cent, while resources firm Pilbara Minerals dropped 7 per cent.

Threat of war

An Israeli ground invasion of Gaza is imminent. A ground invasion has the potential to ratchet-up the seriousness of the geopolitical risks in the Middle East.

A Middle East war involving Iran and Saudi Arabia has the potential, apart from the obvious human tragedy, to lead to a sustained oil price shock.

This would move through the global economy like a wrecking ball.

“The next table looks at the major events that led to the Geopolitical Risk Index spiking to historical extremes and initial market reactions in the US S&P500,” AMP’s deputy chief economist Diana Mousina said.

“This shows that the major geopolitical events are often associated with moderate [sell-offs] in US shares with the six major events highlighted in the table leading to an average of a 10 per cent fall in US shares as an initial market reaction to the event.

“However, it’s important to keep in mind that there are economic factors at play that are also influencing returns, alongside geopolitical risks.

“For example, the period around the Gulf War was associated with a recession in the US and the US/Iraq war in 2003 was occurring right after the US tech crash.

“The current conflict in Israel has been occurring while US bond yields are reaching their highest levels since 2007.”

Inflation threat

This helps explain why there’s heightened anxiety on global share markets at present.

Pandemic economic stimulus and a re-opening of boarders in late 2021 lead to some of the strongest inflation the world has seen in a generation.

This inflation is proving sticky, and it’s now colliding with a war that threatens to further increase the price of petrol and destabilise international politics.

Analysts say it all leads to one thing: higher interest rates, for longer.

“[It’s] all about yields and [the] risk free rate,” Marcus Today’s Henry Jennings said.

“If bonds are a viable alternative, then why risk it in equities?”

What Mr Jennings means by this is that if bonds are offering a return on an investment above that of shares, it makes sense to dump the shares and buy bonds (because they are seen as less risky).

“The Middle East adds another dimension and higher oil prices weigh on economic [growth],” Mr Jennings added.

He said there were no obvious signs of “Chinese [economic] stimulus” at this point which only adds to fears of a global economic slowdown.

“Volumes remain low and [so the] sidelines are a good place to be,” Mr Jennings said.

Again, this is a bit of financial markets jargon. Put another way, it appears many investors are not trading at present and are waiting for the economic and political environment to improve.

Tread carefully

Share markets are inherently risky places to invest, which is why investors demand a premium “return”.

The problem arises when alternative investments offer a similar return, or investment reward, for less risk.

It creates a bit of a rush to the share market exits.

Add to this the rising risk of recession in Australia and the US, uncertainty around China’s economy and property markets, and the looming “high risk”, according to AMP, of a US government shutdown next month.

Analysts agree that while it’s impossible to tell if the share market will fall further from here, expectation is high that the stock market will remain volatile.

That makes sense. War, inflation and human behaviour can be awfully unpredictable.

For younger Australian investors, any big move down like this in shares can represent a buying opportunity.

For older Australians in or approaching retirement, with superannuation heavily invested in shares, it can be anxiety-provoking.

But AMP’s latest note to investors presents some helpful thoughts.

“The next 12 months are likely to see a further easing in inflation pressure and central banks moving to get off the brakes,” the financial services giant noted.

“This should make for reasonable share market returns, provided any recession is mild.”