Market movements - May 2008

The investment market update

Is some calm returning to domestic markets?

The Australian sharemarket has made significant gains from mid-March and has retraced much of its falls from late last year and earlier this year. A sequence of five consecutive negative monthly returns (refer table below) was brought to a close when a positive 4.5 per cent return was posted for April, and a gain of approximately 6.4 per cent recorded so far for the first half of May.

Monthly returns – Australian shares: S&P/ASX 300 Accumulation Index
November 2007	-2.9%
December 2007	-2.6%
January 2008	-11.0%
February 2008	-0.7%
March 2008	-3.4%
Cumulative fall	-19.3%
April 2008	+4.5%
May 2008 (1st – 16th)	+6.4%
Cumulative rebound	+11.2%

*Returns calculated on a cumulative compounded basis

A recovery in the S&P/ASX All Ordinaries Index from near 5000 points to back over 6000 points has created perhaps the first sign of calm returning to the market. Of course, the question going through most people's minds is whether the 'danger is over'?

It really depends on who you speak to. In the wider press, the growing consensus seems to be that the domestic sharemarket lows seen in mid-March (coincident with the collapse of, and subsequent bail-out of, Bear Stearns) may have represented a market bottom. But anxiety still remains. Certainly, most are of the view that the sub-prime crisis still has further to play out and that 'choppy' investment markets are something we will have to endure for some time to come.

As well, it's important to make a clear distinction between 'sharemarket performance' and 'economic performance'. The two are not necessarily closely linked, particularly over the short term. It is certainly possible that we have seen the worst of the sharemarket decline, but ominously, according to the Reserve Bank of Australia (RBA), some pain is still to come for the real economy.

In the RBA's Monetary Policy Statement released on 9 May, it revealed that it has dramatically revised downwards its forecast for Australian economic growth over the 2008 year by a full percentage point, from 3.25 per cent down to 2.25 per cent. Anyone thinking that this opens the way for interest rate cuts should temper this against the RBA's expectations that underlying inflation is also to remain near 4.0 per cent for the remainder of the 2008 year. This is well above the RBA's comfort zone, and doesn't leave them much room to reduce rates.

The aim of the deliberate slowdown being engineered by the RBA is to achieve a 'soft landing' and ease some of the demand and inflationary pressures which have built up within the economy. If successful, this should bode well for longer term sharemarket returns. But it is a delicate process. Too much, or too little at the wrong time, can push the economy into either a harder landing than was intended, or result in an increasing inflationary problem - both of which the RBA (and sharemarket investors) would really rather avoid.

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