From record highs to lows: Why is the ASX 200 taking a tumble?

Interest rate decisions from the RBA and the Fed are hitting the local stock market.

In the world of investing, the only constant is change. Recently, the Australian Securities Exchange has been a textbook case of this adage, shifting from record-breaking highs to unexpected lows.

The S&P/ASX 200 Index (ASX: XJO), the barometer of the Australian stock market's health, closed lower on Tuesday, shedding 0.58% to 7,581.6.

International counterparts such as S&P 500 also threaded lower by -0.3% to 4,942 points.

For many of us, watching these fluctuations can feel like being on a rollercoaster without a seatbelt.

But what's really behind this financial whirlwind?

International exposure: Influence of Wall Street

In the global money world, the big decision-makers, like the Federal Reserve, recently decided to keep its interest rate steady at a range of 5.25%-5.50%. That's the highest it's been since way back in 2001.

But here's the catch – it's not planning to bring it down unless it's sure that inflation is heading back to the 2% goal.

"The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%," the Fed said in its policy statement.

The inflation rate (in the US) as of December 2023 is 3.4%.

Understanding the hesitation

Saxo Head of Equity Strategy Peter Garnry sheds light on the Fed's cautious approach, stating:

"The US consumer is doing okay under the current interest rate regime with the Redbook Sales Index hovering around 5% implying real growth in consumption."

Let's understand this increase.

The 'Redbook Sales Index' hovering around 5% indicates the rate of growth in consumption based on the Redbook Sales Index. The Redbook Sales Index is a measure of retail sales in the United States, providing insights into consumer spending patterns. In this context, when the index is "hovering around 5%," it suggests that retail sales are experiencing a growth rate of approximately 5%.

A growth rate implies an increase in the value of retail sales compared to a previous period (3% as of 3 December 2023). In the context of the discussion about the Federal Reserve's decision-making, a positive growth rate in retail sales is considered a positive economic indicator.

It suggests that consumers are actively spending, which can contribute to economic growth. This is relevant because it gives insight into one of the factors influencing the Federal Reserve's cautious stance – the positive economic indicators reflected in the Redbook Sales Index.

Further, Garnry said: "The weekly indicators on the US economy suggest that the economy is operating close to trend growth."

Here, the Weekly Economic Index (WEI) resembles 10 indicators of real economic activity, scaled to align with the 4-quarter GDP growth rate. The current Gross Domestic Product (GDP) as of December 2023 hiked to 6.3% per Bureau of Economic Analysis.

Note: When the economy is performing well and showing growth, the Federal Reserve typically refrains from cutting interest rates. This is because a robust economy with healthy indicators, such as low unemployment and strong consumer spending, doesn't necessitate the stimulative effect of lower interest rates. The Fed aims to balance economic stability, and in times of growth, maintaining or even raising interest rates may be considered to prevent potential inflationary pressures.

Not to forget the Q4 results of most of the leading companies which painted a positive picture as well.

"When you take all the observations above into account and combine it with Powell's previous comments when inflation erupted that the Fed's models were broken on forecasting inflation, then it is reasonable that the Fed is hesitating to cut the policy rate," Garnry concluded.

Local headwind(s)

Now, how does this impact our Aussie stock market, the ASX? Well, it's like a ripple effect. When big players like the Federal Reserve make moves, it reverberates across the globe. The ASX felt it, and it's part of why we're seeing changes in our local stock scene.

But that's not all.

In the first cash rate decision of 2024 the RBA has decided to keep it at 4.35%, despite borrowers hoping for a rate drop due to slowing inflation.

This decision had a noticeable impact on the ASX with the market dipping further. Sectors that ended Tuesday in the red were S&P/ASX 200 Utilities [XUJ] by -0.9%, S&P/ASX 200 REAL ESTATE [XRE] by -0.9%, S&P/ASX 200 Industrials [XNJ] by -0.8%, S&P/ASX 200 Health Care [XHJ] by -0.4% and so on.

How does this impact an average investor or company?

The RBA's decision to maintain the cash rate can impact Aussie companies and investors in several ways:

• Cost of borrowing. For companies, the cash rate influences the cost of borrowing. When rates remain steady, it may provide stability in borrowing costs for businesses, helping them plan and manage their finances. However, if rates were to decrease, it could potentially reduce the cost of borrowing, enabling companies to access capital more affordably.
• Consumer spending. The cash rate also affects consumer spending. While borrowers were hoping for a rate drop, the decision to hold rates steady may mean that interest rates on loans and mortgages remain unchanged. This can impact consumer spending patterns, influencing how much individuals are willing to borrow and spend.
• Investment decisions. Investors often monitor interest rate decisions as they can influence investment strategies. The decision to maintain the cash rate may impact the attractiveness of certain investments. For example, sectors sensitive to interest rates, such as real estate and financials, may experience varied reactions based on rate expectations.
• Market sentiment. The ASX's decline after the RBA's decision reflects market sentiment. Investors may react to interest rate decisions by adjusting their portfolios, especially in sectors like technology and basic materials that were affected on the day of the announcement.

Navigating the downturn: Strategies and opportunities

While a downturn might seem daunting, it can also present opportunities. Here are a few considerations for those looking to navigate this period:

Stay informed

Keeping abreast of market trends and economic indicators is crucial. Understanding the factors that influence market movements can help investors make informed decisions. Whether it's global economic news or domestic policy changes, being well-informed is key.

Long-term perspective

Market downturns are part of the economic cycle. For long-term investors, these periods can offer buying opportunities. Stocks that were previously overvalued may now be available at more attractive prices. It's about looking beyond the immediate turbulence and focusing on long-term potential.

Diversification

Diversification remains a cornerstone of sound investment strategy. Spreading investments across different asset classes can help mitigate risk. If one sector or market is underperforming, another may be outperforming, balancing out the overall impact on your portfolio.

Consider your risk tolerance

Everyone's financial situation and risk tolerance are different. It's important to assess your own capacity for risk and adjust your investment strategy accordingly. What might be a buying opportunity for one investor could be a risk too great for another.