Beware Sharemarket Panic Selling

Stock market corrections - even large violent ones - can be necessary to take some of the air out of the market before it hits bubble territory. And sometimes the factors that feed into shares falling are signs of a healthy economy.

To be sure, Wall Street broke lots of records as it plunged 4.6 per cent this week following the significant falls last Friday, and there will be a trail of damage for some investors.

And the Australian stock market followed suit on Tuesday - plunging 3.2 per cent - costing investors $56 billion.

But look through this week’s carnage for perspective.

The US stock market has made plenty of positive records over the past month and year. It has done nothing more over the past few sessions that claw back a fraction of those gains.

In 2017, the Dow returned around 25 per cent and, even after the falls of the past few days, the index is still up in 2018.

The market needed some taming. But this week’s pullback may not have the conviction to morph into a sustainable fall or a bear market. But it may remain volatile for a while yet.

This latest market rout comes on the back of US interest rates rising, which is a response to the prospect of rising inflation - a sign of healthier economic growth. This is a good thing.

The trigger for this particular correction was Friday’s US payroll data, which showed wages were rising and employment improving.

Spurred by pro-business tax cuts and deregulation, the US equity market has been lapping up the prospect of higher profits and economic adrenalin.

In most Western countries, interest rates have been chronically low for years as governments attempted to use easy money to stimulate their sluggish economies.

In the post-GFC environment, deflation has been the economy’s enemy.

The US has been threatening to ratchet up interest rates for a couple of years but meaningful moves have been a long time coming.

Markets get spooked by rising interest rates because tighter credit can play havoc with the housing market and makes it more expensive for companies to borrow, thus putting pressure on profits.

(And bear in mind that US companies just scored a hefty tax cut to boost profits.)

Even if there are a couple of rate rises, they will still be low in historical terms.

The underlying US economy is in better shape than it was even a year ago, as are most European economies.

These are the foundations for a stronger stock market. They are certainly the events that smart investors use as a buying opportunity.

In Australia, there is an expectation corporate earnings should rise about 7 per cent or more this reporting season. This should support stock prices, which have risen nowhere near as sharply as in the US.

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