Market movements - October 2008

The investment market update

The financial situation a year on

This is a good time to focus on educating yourself about your investments. Importantly, this is not a time to panic.

We are now coming up to one year since the present financial crisis first became apparent. The severity of the crisis was underestimated by most analysts and financial experts. What was first believed to be a problem largely contained to the US (and primarily in sub-prime lending) has had far reaching implications at a global level.

The root of the financial challenges we are now witnessing was the widespread decline of US house prices. This highlighted weaknesses in some US financial practices but has now had a much broader, knock-on effect.

In recent months, the world banking system has come under immense strain and multiple bailouts and nationalisations of banking interests have been required. Confidence in the global financial system has been damaged despite the efforts of governments and central banks around the world to instil some measure of liquidity and confidence back into the market.

Equity markets around the globe have been savaged to the order of 40 per cent from their peaks approximately one year ago. The current financial crisis is now being described by many commentators as the worst since the 1930s Great Depression.

Australia has not been immune from the widespread sell-off in financial markets. Commodity prices have declined sharply due to fears that a global recession and slowdown in China’s growth will reduce demand for resources. Closer to home, there are fears that house prices in Australia may experience significant declines – some commentators forecasting falls of up to 40 per cent.

With the levels of uncertainty prevailing at the moment, it is easy for more rational responses to be overridden. The situation is grim, but there are some things that should be kept in mind to maintain a balanced perspective on events:

1.	Australia is widely acknowledged to have one of the world’s most robust banking systems. This is important to ensure the smooth running of the economy. So far, Australia’s banks have weathered events far better than most others around the globe.
2.	Financial markets are currently engaged in a shake-out of the excesses that have built up over the past decade or more. Eradicating many of these bad debts and poor business practices is a painful process, but healthy in the long term.
3.	In this kind of environment, share prices are not necessarily an accurate reflection of the ‘intrinsic’ or fundamental worth of a company. Sentiment has taken a battering and this can cause emotion to overrun fundamentals.
4.	In contrast to the recessions anticipated for many developed nations, nabCapital is currently forecasting positive Gross Domestic Product (GDP) growth of around 1.3 per cent for Australia.
5.	The current level of the Australian share market indicates that it is already factoring in recessionary-like company earnings.
6.	The level of interest rates within Australia is currently at a relatively high six per cent when compared to other countries. This provides the Reserve Bank of Australia (RBA) with flexibility to reduce rates as needed in a bid to stimulate the economy. To put this in perspective, this compares to the UK at 4.5 per cent, the European Central Bank (ECB) at 3.75 per cent, the US at 1.5 per cent, Japan at 0.5 per cent and Canada at 2.5 per cent.
7.	Even after a raft of initiatives announced recently, the Federal Government still has a forecast budget surplus of around $7 billion which it can use to stimulate economic growth if required. The Federal Government is also carrying very little debt (only $60 billion or around 5 per cent of GDP). This compares to 66 per cent in the US, 44 per cent in the UK and 166 per cent in Japan.
8.	The fall in the Australian dollar should be a net positive to the domestic economy as it stimulates our export sector.
9.	Financial market declines do eventually come to an end, even when it feels like they won’t.

 

The Australian Government has not been sitting idle during this period of financial market instability. It is fast-tracking a fiscal stimulus package totalling more than $10 billion targeted mainly at pensioners, families and first-home buyers – much of which will be delivered before December this year.

In addition to this, the Australian Government has taken unprecedented steps to shore up confidence in Australia’s financial system. These measures include:

1.	Guarantee of deposits – The Government has guaranteed a full 100 per cent of the deposits in Australian-owned banks, locally incorporated subsidiaries of foreign banks, credit unions and building societies. There is no dollar amount cap and the guarantee will run for three years.
	The practical implication of this is that it virtually eliminates the likelihood of a ‘run on a bank’.
2.	Offer to guarantee wholesale funding – The Government will offer a guarantee on debt securities issued by Australian-owned banks, locally incorporated subsidiaries of foreign banks, credit unions and building societies. This guarantee applies to new and existing issuances of debt securities and will continue for a term of up to 60 months. A fee will be charged for the guarantee.
	The practical implication of this is that it improves banks’ ability to access longer-term funding from the market as it gives investors/lenders confidence that they will have their investment repaid in full.
3.	Additional Residential Mortgage Backed Securities (RMBS) purchases - The Australian Office of Financial Management has been directed to purchase another $4billion of RMBS from non-bank lenders. This is in addition to the $4 billion announced several weeks ago.
	The purpose of this is to promote competition in the home-lending arena by kick-starting the stalled RMBS market which has historically been an important funding source for non-banks.

Most developed countries have adopted similar measures to those above. The only major measure which the Australian Government has deemed unnecessary for the Australian economy at this stage is the purchase of direct equity stakes in banks. A large component of the European, UK and US response includes government funded recapitalisation of banks which will in many cases, see governments emerge as major shareholders. Currently the Government has indicated that there is no need for a recapitalisation of the Australian banking system.

Recent events have shocked investors and the unrelenting pace of the decline in equity markets has caused both disbelief and consternation. While it may be hard to see past the current pall that has been cast over investment markets, there have been a range of measures taken to help stabilise markets. Concerted global government and central bank action has reduced the prospect of a collapse in the financial and banking systems. A global recession is still likely, but this at least is the ‘devil you know’, and something which countries have experienced previously and overcome.

Given the degree of stress markets have undergone, it is highly likely investment returns will continue to be volatile. During these inevitable spikes and falls in the market, it is more important than ever to focus upon your investment strategy.

Superannuation for most is a long term investment and you should continue to think long term.

We strongly recommend you seek advice from a licensed financial adviser and carefully consider your current financial situation and objectives before making any financial decisions.

 

 

News and information

Market watch Investment manager PDSs Glossary of terms  Subscribe to Plum news RSS  News 2008 2007 2006 2005 2004 2003  Media releases 2008 2007 2006  Online videos Who is Plum? Choose your investment mix Consolidate your superannuation Plum Personal Plan