Periods of decline and volatility are a normal part of the way markets operate, particularly considering the influence of investor psychology, says AMP Capital.
In a recent economic update, AMP Capital chief economist Shane Oliver reminded investors that although it feels more comfortable when equities are rising, declines are part of the way markets work.
Mr Oliver pointed out the falls share markets have experienced from their highs earlier this year: Chinese shares -43 per cent, Asian shares (ex Japan) -23 per cent, emerging markets -22 per cent, eurozone shares -18 per cent, Australian shares -16 per cent, Japanese shares -16 per cent, and US shares -12 per cent.
However, Mr Oliver said the current downturn should be looked at as a normal market correction.
“My preferred approach is that a correction is limited to sharp falls, up to 20 per cent or so, across a few months after which the rising trend in share prices resumes, taking shares back to new highs within say six months of the low.”
Australian shares have experienced corrections of around 10 per cent each year from 1996 to 2000 and have subsequently recorded positive calendar year total returns, Mr Oliver said.
“Once share market falls run their course they are usually followed by a strong rebound in the subsequent 12 months.”
“Share market falls boost the medium-term return potential from shares – simply because they make shares cheaper – and once share markets bottom they are invariably followed by a strong rebound."
Mr Oliver reinforced that downturns are a necessary part of the way markets work given that investor psychology plays a huge role in "pushing share markets to extremes".
Mr Oliver added that periods of market weakness reminds investors that investing in equities is not risk free.
“Essentially, periods of share market weakness stop investors from getting too euphoric. They provide a reminder that the outlook is not risk free and they help reset starting point values to provide a reasonable medium-term return potential after periods when returns have run above average,” said Mr Oliver.