Market volatility does not change key drivers of the share market

By ST Wong

Recent market volatility will likely impact the Australian share market in the short-term, driven largely by volatility in the commodities market.

The concerns over commodities can be traced back to problems with Chinese property company Evergrande, which is currently experiencing a debt crisis. This has understandably fed anxiety over China’s near term demand for commodities such as iron ore.

Evergrande’s story is an interesting one, and reminds me a little of some companies I analysed when I was based in Malaysia during the Asian Financial Crisis in the 1990s. Similar to a number of Asian companies, particularly property companies in the 1990s, Evergrande over-extended its balance sheet and engaged in number of non-core businesses.

During the Asian Financial Crisis, I recall biscuit manufacturing companies over-geared to enter property development on a big scale, only to see demand shrivel. Evergrande fits that bucket of over-geared companies venturing across non-core businesses then finding themselves in a tangle—in Evergrande’s case, a US$300bn tangle.

However, while the Asian Financial Crisis reflected widespread systemic problems, Evergrande does not look like a systemic issue. It is more an economic problem.

The financial institutions in Asia are not overly exposed by Evergrande’s debt challenges, and the Chinese financial services industry can absorb this issue. Chinese policy makers have been on the Evergrande case for over a year, working to ring fence the issue to stave off systemic risks. Similar to developed economies, the Chinese authorities value consumer confidence, and we expect them to bolster the diminishing confidence in the Chinese property market.

Evergrande is likely to remain in the news headlines over the next few months. This is because information surrounding the short-term specifics of Evergrande’s problems are not known. Further, we are uncertain of China’s policy approach to reduce excessive investment and speculation in properties—Chinese authorities may look to reduce the leverage of financial institutions and property companies. The consequence is for lower, but more stable, Chinese economic growth.

While we expect commodities to be volatile short-term, when we look through the current noise to consider the next 18-24 months, commodities look sound. However, markets react to short-term concerns which is why stocks such as BHP look like they have been recently oversold.

At Prime Value, we believe the key drivers to economic and market performance have not changed. The key factors are:

  1. Low interest rates, which are providing significant stimulus into the global economy. There is still no sign of interest rates climbing dramatically in the near future and we should see them continue to influence activity for the next few years.
  2. The new economic cycle, driven by a global recovery from COVID-19 lockdowns. This cycle should see slightly higher inflation, and higher growth globally, along with an uptick in corporate activity and capex spending.
  3. Companies are better positioned, a fact underlined by the recent reporting season. Balance sheets are strong, debt does not look to be a structural concern and it is unlikely a liquidity crisis will emerge.

We can expect many bumps along the way, but the opportunities to pick good companies through this next economic cycle looks promising.

ST Wong manages the Prime Value Opportunities Fund: this Fund is open to all investors. To invest in the Prime Value Opportunities Fund, please contact our Client Services Team at info@primevalue.com.au and 61 3 9098 8088.

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