Market Update - August 2011

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A balanced view on today's global markets and your investments

Events within global markets are concerning for many investors. Despite strong overall returns in the two years to the end of April, share markets globally have fallen sharply on the back of US economic growth concerns, debt issues within the Eurozone and low market confidence in the ability of policymakers to increase economic activity.

Does it seem like déjà vu all over again? At face value it appears that we are going through a replay of the Global Financial Crisis of 2007 and 2008 - or as the Reserve Bank calls it, the North American Financial Crisis. But as always is the case, no two events are precisely the same.

Back in 2007 the issue was the US over-investment in housing, translating to lower home prices and exposing the loans made by banks to sub-prime borrowers. In addition soaring commodity prices - especially oil - were adding downward pressures on the economy. In January 2007, oil was at US$50 a barrel; a year later it was near US$100; and in July 2008 oil was at US$145 a barrel.

In July 2007 major sharemarkets were at or near historic highs. And despite a period of  consolidation, sharemarkets revisited the highs in late October/early November 2007, just as the US economy was about to crumble.

The GFC was a banking crisis. Major US banks lent to people that shouldn’t have had loans in the first price. Too many homes were built, home prices fell, banks were hit by bad loans, investors in mortgage securities were similarly affected and some banks failed or were taken over. The crisis in the banking sector led to a global crisis of confidence, exacerbating the economic downturns in advanced nations.

This time around, the crisis is centred on countries, rather than banks or companies. While corporate bank balance sheets are in stronger shape, the US and European countries are carrying higher debt levels as a consequence of trying to support economies through the GFC.

But sharemarkets are starting from lower levels than in 2007. Oil prices are far lower than at the peaks in 2008 as are interest rates. While we are experiencing a crisis of confidence as we did back in 2008, household and business balance sheets are generally in far stronger shape, courtesy of efforts to cut debt and increase saving.

Fortunately Australia is again in a position of relative strength in this new era of uncertainty. The cash rate stands at 4.75 per cent, meaning the Reserve bank has plenty of firepower at its disposal. Market rates have already fallen markedly and already these lower yields are being reflected in fixed-term lending rates.

Australia’s government debt to GDP ratio is also the lowest in the industrialised world, meaning that there is capacity to boost spending to stimulate growth. However given past experiences there will be more scrutiny on the measures taken.

The purpose of this letter is not to convince you that all is well, as volatility will continue throughout the world, and therefore Australia for many months to come. Our aim is to help you make sense of current financial events and offer some guidance for the future. While we are confident of better times ahead we recognise that these types of market conditions can test the resolve of even the most experienced investors.

Current issues

The US debt ceiling debate has drawn attention to America’s public debt problems and brought fiscal austerity at a time when the US economy is showing new signs of weakness (e.g. slower than expected GDP growth, weak   manufacturing data). The recent credit rating downgrade is another headwind for the US economy.

There is growing concern that the sovereign debt saga in peripheral Europe could worsen and spread across the broader region. The potential sovereign debt liquidity issues affecting large European countries (particularly Italy and Spain) have seen bond spreads growing to post-euro record highs. Currently the attention is on Italy (Europe’s biggest debtor) and its capacity to rollover its debt.

Markets are worried that policy makers will not be able to put the economy back on a path of growth with proper job creation. These worries have been amplified in recent weeks in the US (i.e. political dysfunction exposed by the debt ceiling debate) and in Europe (i.e. policymakers continuing to be reactive rather than pre-emptive).

Outlook

Actions taken by governments and central banks (in the main in Europe and the US) will remain a key driver of   market volatility. Sovereign debts levels will continue to disrupt markets until balances become more manageable though it is likely markets have already priced in much of this concern. A few points to make here are:

  • There is a lot of cash on the sidelines;
  • Most large corporations have strong balance sheets and increased profit numbers;
  • The outlook for China is positive and despite recently putting the brake on a possible property bubble and inflation concerns, China has the luxury of being able to use both a brake and an accelerator;
  • Australia is well placed with low unemployment, a high savings rate, the ability to reduce interest rates and introduce more fiscal stimulus if need be; and
  • While the ride for share markets and other assets may remain rough in the short-term, taking a longer term view they are likely to be supported by attractive valuations.

As you already know we believe that reacting while or after markets have already declined usually does more harm than good. We also believe that the probability of long-term investment success is higher for investors who plan and implement a sensible investment strategy and stick to it. A lesson learned from the Global Financial Crisis and other similar unnerving market declines is to ensure that cash is set aside for short term liquidity needs. Beyond that, we look to reinforce the importance of portfolio diversification and a long-term investment focus. The message during this period of heightened volatility is no different.

We appreciate that market downturns can be an uncomfortable time for investors and intend to keep you up to date with developments. If you would like to discuss these matters, review your portfolio or discuss developments in more detail please contact this office on 08 9474 2255.

*The information and data in the above market update is sourced from CBA, AXA, AMP as well as editors personal views.

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