In the last few weeks we have seen sharemarkets around the world fall heavily, mainly as a result of concerns over sovereign debt issues both in the US and parts of Europe and also because of the economic statistics clearly
showing that the US economic recovery is waning.
While many of these issues have been in the news for a while now, much of the current correction and turmoil in sharemarkets is due to the realisation by many investors that economic growth will be much slower going forward than many previously predicted. As a result corporate earnings will also not be as strong as hoped going forward.
To help give you an understanding of the current issues and how others, considered experts in their field, view the current situation we have placed some comments here for you. No doubt you will have seen other comments as these events are getting a lot of coverage by the reliably dramatic media. These comments will hopefully held give you context to the current situation.
Should you wish to discuss any of this, please feel welcome to call us on (02) 9221 7777.
Ian Huntley - editor of Huntleys' Your Money Weekly
Last night's mini-crash in the markets had the smell of total fear. My reading is that European issues triggered the rout, with the European Central Bank failing to purchase Italian and Spanish bonds as they continued to edge higher in yield against German bonds. French and German banks will take the brunt of any emerging shocks, should the crisis develop further. As noted in the preceding overview, Italy and Spain are classed as too big to be allowed to fail, and too big to save.
Our market will be testing the lower end of my mooted 4000-5000 trading range, and will possibly test the 3800 area I suggested in the overview as being an "end of the world" area.
My view continues to be that our market offers very good value in a range of quality stocks, including our banks and leading resource stocks, where BHP Billiton (BHP) (diversification) and Newcrest (NCM) (gold and copper) stand out to my mind.
The All Ordinaries index has now made a slight new low for the year near 4350 - surprising me, as I had expected a firmer market post the US debt resolution. I correctly expected the price of gold to falter and then forge ahead.
The basic issues remain US debt continuing to grow, as well as the problems of Europe. An index of close to 5000 by year-end is still to my mind likely, very much a replay of last year. It's in line with my forecast of several years for the market to trade between 4000 and 5000, though this year I did think 4500 would hold, as stated in a recent report.
The market could possibly briefly fall to the 4150-4200 area and a chartist friend reckons 3800 is the worst case "if they reckon the world is ending again".
My expectation of no rate rise and a possible 0.5 per cent rate cut by Christmas is now close to consensus. as it is now the futures market's prediction. I simply work on the view of the economy as seen through the eyes of our team of analysts, who constantly keep on top of just how their companies are faring.
And the Reserve Bank of Australia (RBA) realises that, yes, "it is the economy stupid," and the price of bananas is not continuing inflation.
The price of copper hardly faltered through the recent alarms and headline falls in the US market, and gold forged to major new highs of over US$1670. Our currency pulled back as the markets figure on possible lower interest rates.
Copper and gold are far more important to our economy than whether US Congress can agree on the US debt ceiling and ways to get their budget in order. That's not hard - the US is under-taxed after years of the tax revolution instigated by Ronald Reagan, when it was very necessary. Means testing of social welfare would be a major help, as would a few dollars tax on fuel.
It's important to focus on the world around us, as it is, and not to take the headline horror too seriously - but it does helps create value when investors leave the market thinking they are in Greece, Spain, Italy, Ireland, Portugal or the US! Hey, we are in Australia - we are a major commodity exporter with one of the best government balance sheets in the world. This is despite having a government that is best described in the words of a friend: "The US is kicking the can down the road, and we are kicking ourselves in the foot."
The global outlook is for good growth of around 4 per cent per year, heavily led by the developing world and held back by weak growth in the developed world, plagued as it is by sovereign debt issues.
Led by China, the developing world is massively investing in infrastructure including homes, and needs the raw materials we sell as the treasure house of Asia. Global agricultural production is under stress, prices are rising and we are a major exporter of key foods. The Chinese economy is going to be in a major growth phase for the next 10 to 15 years. And sure, there will be hiccups. And it is followed by India and other countries to boot.
Worried about a US downgrade? Give it a miss! Since when have the US rating agencies ever been on the ball with these things? The market has already factored all that in. Interest rates will not go up. The US economy is either on the verge of recession, or is already in recession and faces major under-utilisation of capital resources and labour.
Real unemployment is just on 17 per cent. The housing industry is stuffed for years, given that 16 million of the 50 million homes with mortgages are under water - and these are the guys who can walk away from their mortgages under lunatic US regulations. Nouriel Roubini projects another 8 million homes will be under water over the next year to 18 months. I don't see the US mounting any decent sort of economic recovery until new housing and all the multipliers it generates gets a move on.
Don't confuse the US economy with the major US sharemarket indices. They are populated by wonderful multinational companies like GE, Colgate, Caterpillar, Exxon, and Apple, just to name a few. Many of these make well over 50 per cent of their annual profit in the burgeoning developing world, helped by a weakening US dollar. One can argue the developing world now stands on its own multi-feet and is not inexorably connected to the US.
The Eurozone faces the PIIGS (Portugal, Ireland, Italy, Greece and Spain) issues, but there the major economy by far is Germany. As the PIIGS weaken the euro, Germany cheers, for it helps boost its exports.
The Germans aren't stupid either. They are exporting hand over fist into China, providing the capital machinery for China to be the manufacturing centre of the world, gouging out many of the industries that formerly underpinned Italy, for instance.
The world does not face a massive credit squeeze as it did in 2007-09. It does face a liquidity trap in the US, and problems with major French and German banks writing off PIIGS' sovereign debt. That has already begun and is likely to be with us for many years.
Can the US get its act together? Sure it can, but only as Winston Churchill says - after it tries everything else. It needs to raise taxes, cut expenditures and do a couple things I mentioned previously.
Remember Paul Keating back in May 1986, declaring Australia a "banana republic"? He ushered in a series of wonderful reforms under Labor, and Liberal governments then left us in a great position.
Obviously, I do not have the same view of the current government, who to my mind are taking us backwards. But they only hang on by one seat and one independent holding steady.
Magellan Asset Management
The sovereign debt issues in Europe and recent poor economic data out of the United States have led to considerable market volatility in recent days and months. The sovereign debt issues in Europe cross two complex and associated issues.
The first issue is a solvency issue.In our view Greece is effectively insolvent and Portugal and Ireland have potential solvency issues. The good news is that the European Union and the European Central Bank have finally recognised the insolvency issue in Greece. The new Greek bailout package is a fundamental step in the right direction. The package materially reduces Greece's financial burden via the extension of loan terms and the reduction in interest rates; these measures were also extended to Ireland and Portugal. The proposed involvement of private sector creditors to swap Greek sovereign debt for longer duration lower interest debt will also materially reduce the present value of Greece's outstanding debt. This reduction in Greece's debt burden is a fundamental step in putting Greece on a path to sustainability. We suspect that more still needs to be done, however we are optimistic that the tools and policies are now in place to address Greece's solvency issues.
The second issue engulfing Europe is a potential sovereign debt liquidity crisis affecting larger European countries, particularly Italy and Spain. We do not believe that either of Spain or Italy are insolvent, however a collapse in bond market confidence could push yields on sovereign debt to levels that create a true liquidity crisis. In our view monetary union presents particular challenges to addressing this situation. For a country that has its own currency and an independent central bank able to readily print money this situation would be addressable. In such circumstances the central bank could print money and buy bonds on the open market to drive down yields and monetise government funding requirements. The current policy path potentially involves the European Stability Fund (which is constrained in size) and the ECB buying affected bonds (with necessary offsetting asset sales) on the market to stabilise yields.
Unfortunately if this situation continues to escalate and in the absence of a dramatic and possibly unlimited increase in the size of the European Stability Fund, this policy path is akin to bringing a pea shooter to a gun fight.
We do believe that there are two potential policy options which would address these liquidity difficulties; either allowing the ECB and EU central banks to print money or allowing the EU to issue Eurobonds to finance the struggling economies.
We feel it is unlikely that these liquidity issues will result in a financial Armageddon scenario and that correct policies will eventually be pursued. However there are divergent views on the correct path of action and thus we could have a sustained period of considerable volatility until this is resolved.
We remain realistic and relaxed about the difficulties facing the US economy.The recent decision to raise the US debt ceiling has removed considerable risk in the short term and we are confident that the US will take action over the next few years to ensure it is on a sustainable long term fiscal path.
Clearly markets are now holding a gun to the head of global central banks, expecting further liquidity initiatives rather than just currency manipulation. The trigger for the rout seems to have been the BOJ's intervention in the YEN, which triggered a USD rally that in turn led to a full blown liquidation of the carry trade (note record volumes). You know it's a true rout when gold equities lose -6% simply because they are equity.
However, we can all see our screens and see the indiscriminate carnage. There simply was nowhere to hide but cash. ASX200 SPI futures are trading down -157pts at 4085, which equates to an -18.5% correction in Australian equities despite Australia having the strongest GDP growth, lowest unemployment, highest interest rates, highest terms of trade, and strongest AAA rated Federal balance sheet in the OECD. The fact the ASX200 has been belted harder than the Eurozone and US markets still amazes me because at least we do have the ability to pull both monetary and fiscal policy levers here to avoid further economic contraction.
He also have a record high savings rate and record levels of cash parked in term deposits. Similarly, Australian corporate balance sheets are in superb shape, with BHP Billiton leading the way as a net debt free company. Yet, that didn't stop BHP shares being smashed last night to $38.34. Interestingly, spot iron ore was actually up last night which shows China kept buying the stuff.
What I am trying to point you to is the relative and absolute strengths of Australia, and the optionality we have at a policy level, household level, and corporate balance sheet level to respond to these global events. We are in excellent relative shape, but of course that doesn't stop our asset classes from being caught in the global downdraft.
I believe the events of this week in markets and commodities will ensure the RBA slashes cash rates. It's hardly like inflation is going to be a problem. Similarly, capex intentions will be being wound back by corporate and the RBA's concerns about wage price inflation breaking out look very premature. We will have a series of rate cuts in Australia before Christmas, and they may well start earlier than you think. For the RBA this is the repeat of 2008 when they were hawkish a month ahead of the GFC, then made "emergency" rate cuts over the following six months.
The biggest problem Australia faces is the events of this week in markets, global and local, will be the trigger for employers who have held off reducing staff levels, to actually do it. That is why the RBA will act far quicker than anyone currently believes.
Obviously QE3 or some version of it must come from the Fed. While it's debatable whether QE2 actually worked, other than to drive up asset prices, then down when it ended, I think we would all rather have asset prices firmer than what we see today. The Fed will do something and much quicker than markets expect.
At an equity market level we will have the ongoing issue of fund redemptions, stop loss selling, margin call selling, ETF and warrant selling and just outright dreadful sentiment. Australian's were already sceptical of the equity market and this week's events will only further reinforce that scepticism/cynicism with equities as an asset class. What I am saying is that while value and yield opportunities today will be unprecedented in Australian equities, it's going to be a long and slow road back to the asset class being the household darling it once was.
At WLM we understand the concerns investors may have during times like this. Unfortunately we have experienced times like this before. We also recognise the opportunities that are created out of such turbulent times as sentiment can depart from economic reality.
If you would like to discuss current market conditions and how they may relate to your investments, please feel welcome to call us on (02) 9221 7777.