Beware of the bear market

It has taken just one month for the New Zealand sharemarket to wipe out the gains made since July last year.

On Tuesday the NZX-50 hit a new low of 3003.83 points - a 10 per cent drop since the most recent high on April 14, and an official sign of a correction.

Yesterday the market bounced back up 0.43 per cent to close on 3047.75 points but with fears about Europe's sovereign debt crisis and China's property market, a bear market could be right around the corner.

Fund manager and Devon Funds Management principal Paul Glass says there is a chance of New Zealand heading into bear territory but he doesn't believe it is likely.

"There is potential but it's not my base case."

Glass says fundamentally the outlook for New Zealand and Australia is on the up.

"Both the New Zealand and Australian economies are performing very well. Most of the economic surprises in New Zealand and Australia have been on the upside. The economies have responded well to government stimulation."

He says it's ironic, given the pick-up, that the New Zealand sharemarket is being dragged down.

"We are very much a cork bobbing in the ocean. Our market and currency is very much being moved by international events."

Glass says a big part of the problem is that this time the fear stems from governments being in trouble.

"When you look at the global financial crisis the problem was in the banks and the financial system but we had a buyer of last resort - the Government.

"The problem with this current crisis is that the issues relate to the buyers of last resort themselves and there is no one to stand behind that. That is why people are so concerned about it."

Glass says a high level of speculation combined with the ease with which news can now be communicated worldwide was also dialling up the level of volatility in the market.

"Markets are not acting fundamentally as they were intended to. The hedge funds and speculators have too much power. Things that are problems are being stress-tested to a degree they shouldn't be. There is no doubt Greece has problems but speculators are putting the blow torch on it.

"Thirty or 40 years ago you might just be hearing about some problems in Greece now. Today within seconds of something happening the whole world knows about it."

Glass says historically when there were debt problems they would get sorted out over a period of time.

"What is happening now is the financial markets are insisting the problems are dealt with today and that is causing volatility. It is very destructive."

Market commentator Arthur Lim isn't convinced the market is back in bear territory and says it is more about nerves.

"What we are cumulatively seeing is risk aversion rather than a concentrated sell-down because of fears the world is going to go into a deep-seated recession."

In 2007 and 2008 markets sold down aggressively because people wanted out and at the same time companies had a very high level of debt.

"This time around nerves are still quite raw from the experience people had in 2007 and 2008. Investors are saying it's time to take some money off the table."

Lim says the sudden drop in the market in the past six weeks shows the "fear factor" is in play.

"But it's about risk aversion rather than a full-blown fear of recession coming back."

The big difference this time, he says, is that the sell-down is coming against a backdrop of the United States economy recovering.

But what it does mean is that investors need to get used to the idea of seeing more ups and downs in the market. "What we are going to be in for is a much higher level of volatility."

Lim says people need to get used to the idea that growth is going to be much slower.

"Since the early 1990s we have had steady progressive growth, we just haven't had any recessions. What the world has got to get used to is the kind of recoveries we had in the 70s and 80s. Volatility is going to be higher and there will be sharper economic cycles."

Craigs Investment Partners director of private wealth research Cameron Watson believes the volatility is just part of the process of working through the recovery from the global financial crisis.

"There will be lower growth and people are going to have to pay back debt."

Watson said the concern he had was whether people had really factored in the new norm of lower growth.

When the market bounced back strongly at the end of last year, he said it quickly began to look overdone. "You can't fix things in a few months from a financial crisis this big."

Watson says while investors were faced with a tough ride, the crisis was good for encouraging reform and that was the issue Europe needed to face.

But although the focus is on Europe, Lim reckons the key to normality is the United States.

"The US is still the powerhouse economy. The US needs to grow and grow well for a couple of years and then, I think, the global economies will stabilise and we won't see such short sharp corrections."

For now his advice to investors is to stick to quality and not take excessive risks.

MARKET TRENDS

Correction

A short-term price decline in a stock, bond, commodity or index. Usually at least 10 per cent in a market which had been rising.

Bear market

A general decline in the stock market where investors go from having high optimism to widespread fear and pessimism. While there is no agreed definition, one measure is a price decline of 20 per cent or more over at least two months.

Bull market

Increasing investor confidence and increased level of investment in anticipation of future share price gains.