World

Mon Apr 7

Financial markets are tanking. Here’s why it’s best not to panic

Written by: Luke Hartigan, Lecturer in Economics, University of Sydney

Financial markets around the world have been slammed by the Trump adminstration’s sweeping tariffs on its trading partners, and China’s swift retaliation.

Share markets have posted their biggest declines since the COVID pandemic hit in 2020, as fears of US recession surged. Iron ore, copper, oil, gold and the Australian dollar have all tumbled.

On Wall Street, leading indices ^[1] have fallen around 10% since the tariffs were announced, while the tech-heavy Nasdaq is down 20% from its recent peak. European and Asian markets have also slumped.

In Australia, the key S&P/ASX 200 slid another 4.2% on Monday to levels last seen in December 2023, taking its three-day losses since the announcement to more than 7%.

Why are markets reacting so badly?

Financial markets reacted so negatively because the tariffs were much larger than expected. They represent the biggest upheaval ^[2] in global trade in 80 years.

Many traders were hoping the tariffs would be used mainly as a bargaining tool. But comments ^[3] by US President Donald Trump that markets may need to “take medicine” seem to suggest otherwise.

The tariffs are expected to weaken economic growth in the US as consumers pare back spending on more expensive imports, while businesses shelve investment plans. Leading US bank JP Morgan has put the chance of a US recession ^[4] as high as 60%.

This comes at a time when the US economy was already looking fragile. The highly regarded GDPNow model developed by the Atlanta Federal Reserve Bank ^[5] indicates US March quarter GDP will fall 2.8%, and that was before the tariff announcement.

Worries about global growth

Fears of a recession in the United States and the potential for a global downturn has led to a broad sell-off in commodity prices, including iron ore, copper and oil. Further, the Australian dollar, which is seen as a barometer for risk, has fallen below 60 US cents ^[6] in local trading – its lowest level since 2009.

Treasurer Jim Chalmers on Monday. Dean Lewins/AAP

While the direct impact of tariffs on Australia is expected to be modest (with around 6% of our exports going to US), the indirect impact could be substantial. China, Japan and South Korea together take more than 50% of Australia’s exports, and all have been hit with significantly higher tariffs.

Treasurer Jim Chalmers said on Monday that the direct impact on the Australian economy would be “manageable ^[7]”.

The full effect on Australia will depend on how other countries respond, and whether we can redirect trade to other markets.

The rapid decline in the Australian dollar will help offset some of the negative effects associated with a global downturn and the fall in commodity prices.

We can also expect some interest-rate relief. Economists are now predicting three further interest rate cuts ^[8] by the Reserve Bank, starting in May. This brings economists into line with financial market forecasts.

Hang in there, markets will recover

Watching equity markets tumble so dramatically can be unsettling for any investor. However, it is important to note that equity markets have experienced many downturns over the past 125 years due to wars, pandemics, financial crises and recessions. But these market impacts have generally been temporary.

History suggests that over the long term, equity prices continue to rise, supported by growing economies and rising incomes.

The key thing for investors to remember is to not panic. Now is not the time to decide to switch your superannuation or other investments to cash. This risks missing the next upswing while also crystallising any current losses.

For example, despite the steep market sell-off in March 2020 as the first COVID lockdowns came into effect, the Australian share market had completely recovered those losses by June 2021.

It is good practice for investors to regularly reassess their risk profile to make sure it is right for their current stage of life. This means reducing the allocation to riskier assets as investors get closer to retirement age, while also maintaining a cash buffer to avoid having to sell assets during more turbulent periods such as now.

Super funds are exposed to global risks

The current sell-off has highlighted a potential issue facing the superannuation industry.

So much of our superannuation is now invested in global equity markets, mostly in the US, because Australia’s superannuation savings pool ^[10] – at more than A$4 trillion – has outgrown the investment opportunities available in Australia.

Another issue facing the superannuation industry is the growth of cyber attacks, with several funds targeted in a recent attack ^[11]. Given the massive size of the assets held by some funds, it would seem they need to improve their security to be on par with that of the banking system.