Australia Reviews

There’s nothing more to be said about the markets last week except that we all survived, battered, bruised, shell shocked and worse if you were shareholders in some American companies no longer with us like Lehman Bros, Merrill Lynch, AIG, Macquarie, HBOS and a host of other financial stocks.This week events will be dominated by the shape of the rescue body announced Friday to bailout the dodgy securities.Here in Australia we have banned all short selling, not just the naughty naked kind, in a new development revealed last night by the financial regulator, ASIC. It starts from today and continues until further notice.It is a step up of the ban on naked shorting announced Friday.But the big issue is the $US700 billion bailout fund which is likely to provide an opportunity for ambitious and idiotic US congress representatives to try and add pet deals of their own to the bill.Markets around the world simply love the idea, but that affection will be hard to hold as the fund takes ages to have any lasting impact.The Standard & Poor’s 500 dropped by more than 4.7% twice last week after Lehman Brothers’ collapse; Bank of America Corp’s takeover of Merrill Lynch and the US government’s seizure of American International Group.But the S&P 500 ended the week by jumping 8.5% on Thursday and Friday on the US government’s plan to purge banks of bad assets, crack down on short sellers and to stand behind money market funds through support from the Federal Reserve.Shanghai surged 9.5%, in the biggest daily gain for seven years, to 2,075.091.Hong Kong’s Hang Sang gained 9.6% to 19,327.73, London’s FTSE 100 had its biggest daily gain in its 24-year history, jumping 8.8% and in Australia the ASX 200 was up 198 points or more than 4.2% on Friday.It was the biggest two-day global stocks rally in 38 years. Friday’s rallies in London and the US were partially fuelled by bans on short-selling in financial stocks announced on Thursday night.Besides the S&P 500’s gains the Dow added 929 points from Thursday’s low and markets from the UK, China, and Australia and elsewhere surged as investors appreciated the fact that the great panic had been halted for the time being.But it is short term, even the new fund being set up to help buy the so-called toxic securities by the US Treasury.The longer term issues will be the newly increased size of the US deficit and debt, the impact of this huge expansion of money supply on inflation, and most of all the slumping US economy and the disaster that is the US housing sector.The S&P 500 ended up 48.57 points to 1,255.08 on Friday, the Dow surged 368.75, or 3.4%, to 11,388.44 and Nada rose 74.8, or 3.4%, to 2,273.9.The MSCI World Index of 23 developed nations’ markets jumped 5.7% to 1,286.44 on Friday and rose 8% over Thursday and Friday. Europe’s main regional index (the Sox 600) rose a record 8.3% Friday and the MSCI Asia Pacific Index added 5.5% Friday.The S&P 500 actually erased its fall to close up 0.3% for the week, but it is still down down 15% this year.Market reports said a record 3 billion shares were traded on the NYSE on Friday: that was more than double the three-month daily average.Under pressure investment banks, Goldman Sachs and Morgan Stanley saw their shares leap more than 20% on Friday as shorts scrambled to cover themselves.Traders said that only consumer staples, the best performing group this year, fell led by Wal-Mart, the world’s largest retailer.Its shares fell almost 3% for the biggest decline in the Dow.That reaction has a touch of unreality because it won’t be too long before investors start worrying about the economy and banks again and go back into consumer staples.US and European government bonds tumbled; reversing gains made earlier in the week as investor sold equities and commodities and moved into bonds as quickly as possible.The proposal from Paulson and Bernanke (and strongly supported by president Bush over the weekend) is aimed at isolating devalued mortgage-linked assets at the root of the worst credit crisis since the Great Depression.US Congressional leaders said they aim to pass legislation soon, but some have started wondering about loans to US car companies like General Motors and a $US50 billion stimulatory package to follow the $US120 billion tax rebate which came and went from May to July of this year.That sort of grandstanding is going to be dangerous, and expensive.In Australia the major banks led the surge on Friday and today the market is forecast to be up by around 130 points, if Saturday morning’s overnight futures finish is any guide.The ASX200 index finished up 196.8 points, or 4.27%, to 4804.1, while the All Ordinaries index ended up 188.8 points, or 4.06%, to 4840.7.The National Australia Bank soared $3.40, or 17.35%, to $23.00; the Commonwealth jumped $2.62, or 6.54%, to $42.70; the ANZ rose $2.26, or 14.63%, to $17.71; and Westpac ended up $1.54, or 7%, at $23.54.But the focus was on Macquarie Group: after being belted up to the close Thursday, it rocketed $9.85, or 37.81%, to $35.90 after touching an intraday high of $38.55 just before noon.Suncor Metway leapt 75c to $9.10 as the company completed the underwriting on its dividend reinvestment plan two weeks early.In resources BHP Billiton ended up 40c at $35.40 and Rio Tinto jumped $3.10 to $101.50.Iron ore miner Fortescue Metals Group added 50c to $5.70 despite reporting an annual bottom-line net loss of $2.8 billion and saying it would not provide a forecast for the current year because it may prejudice “the interests of the company”.Oil and gas producer Woodside Petroleum was up $2.66 at $54.06, and Santos 53c to $18.28.Newmont dropped 55c to $4.92 and gold fell; Newcrest eased 65c to $23.85 and Lehar dropped 3c to $2.45.The Australian dollar finished higher in New York at 83.40, US cents after the US dollar lost ground as nervy investors sold the currency.Earlier, the Aussie had finished around 81.15 on Friday, up about 1.3 US from Thursday’s close of 79.88. That’s up 3.5c in two days, or almost 5%.And naked short selling will be banned on the Australian Stock Exchange from today.But in a dramatic decision the regulator, the Australian Securities and Investments Commission has banned ALL short selling for a month from today, not just the naked variety. ASIC said the widened ban would act as a circuit breaker to restore investor confidence.Short selling, where traders seek to profit by selling borrowed shares of companies to then buy them back, in the anticipation their prices will drop, has been partly blamed for the sharp falls of stocks such as Macquarie Group in recent days.Naked short selling, involves selling without first borrowing the stock, or even ensuring the shares can be borrowed.The Australian Securities Exchange (ASX) said on Friday it would remove all securities from its list of stocks approved for naked short selling from Monday.The ASX said the “The removal will remain in force until further notice.”"It will be reviewed when the government’s foreshadowed legislative amendments to the reporting of covered short selling activity take effect.”But last night the ASX ban was supplanted by the wider ban from ASIC.ASIC chairman, Tony D’Aloisio, said “To limit the prohibition to financial stocks, as has been done in the UK, could subject our other stocks to unwarranted attack given the unknown amount of global money which may be looking for short sell plays.”

IMPORTANT: AIR reports about financial markets and investment products in the widest sense possible. The AIR website and all its contents is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before making any investment decisions.

If anything, the current turmoil and its impact on credit markets and confidence could have the effect of bring on another rate cut next month in Australia next month, says the AMP’s chief economist and strategist, Dr Shane Oliver.He says that with financial turmoil intensifying again, various commentators have been making comparisons to the 1930s, shares have been hitting new bear market lows (Australian shares are now down 34% from last November’s high, US shares down 24% and Asian shares are off 40%) and the global economy looking more and more shaky.”Its easy to get very bearish, with predictions of a long term bear market based on an unwinding of household debt levels and slump in consumer spending made worse by the credit crunch becoming more common.”For some time we have been of the view that shares would remain weak into September/October ahead of better conditions later this year and going into 2009.While the ongoing turmoil in the US financial system indicates that the risks have gone up and that shares may see further downside in the next month or so, our assessment is that a long term bear market in shares is unlikely,” he says.With financial turmoil in the US intensifying again on the back of Lehman Brothers failure and concerns about other companies, claims that the current situation is the worst since the 1930s, shares making new bear market lows and the global economy continuing to deteriorate its easy to get very bearish. In fact there are many who argue shares are now in a long term bear market led by an unravelling of debt, asset prices, consumer spending and profits.This note reviews the main issues and why we think such a long term bear market is unlikely.The long term Bear caseMost predictions of a long term bear market in shares focus on the US. Firstly, it’s argued that shares may not be overvalued relative to the current level of company profits but there has been an unsustainable bubble in profits and if this is adjusted for shares are expensive.One way of doing this, popularised by Robert Shiller in his book Irrational Exuberance, is to compare shares to a trailing ten year average of earnings and when this is done the price to earnings ratio (PE) for US shares is still above its very long term average, and it usually overshoots below its long term average. The next chart shows this for the US.Secondly, it’s claimed by the long term bears that the bubble in profits has been fuelled in large part by a housing bubble in the US and other key countries including Australia which in turn has been underpinned by a massive rise in household debt levels (see the next chart) which has all resulted in a consumer spending spree.Finally, the perma bears argue that thanks to the US subprime crisis and resulting credit crunch the housing bubble is now bursting and this has set off a debt deflation spiral like Japan experienced in the 1990s and the US in the 1930s.This would run something like this: falling house prices result in loss of wealth and reduced consumer spending which results in tougher economic conditions which results in rising mortgage defaults and less demand for houses and reduced bank lending in response to their mortgage losses which results in further falls in house prices and so on.It’s claimed that the US and UK are already embarking along this debt deflation spiral – only made worse by the latest bout of financial market turmoil – and that Australia is just starting.As a result, the long term bears argue that the bear market in shares has only just begun. This all raises several issues.What is an appropriate long term PE?There are several reasons to believe that the appropriate PE has moved up over time.Share markets today are highly liquid, transaction costs are very low and it is easy to set up a diversified portfolio to reduce risk.And the volatility of economic activity and wages has declined dramatically over the last century which should result in a higher level of investor risk tolerance.These considerations suggest investors would be happy to buy shares on a higher PE today than was case in the distant past and as a result the fair value PE today is likely to be higher than it was in 1900 or 1950.If this is the case it would mean that even after smoothing out the surge in profits over the last few years shares are still not expensive.Has there really been a bubble in earnings?There is no doubt that the level of earnings increased at an unsustainable pace in recent years on the back of strong productivity growth, more flexible labour markets and the resources boom in Australia’s case.This has taken margins and profit shares of GDP up to record levels as evident in the chart below for the US and Australia.While its to be expected that the profit share will fall back a bit as is already occurring in the US and that the long term profit growth will slow to a more sustainable pace there is no reason to expect the profit share of GDP to collapse: the sort of wages pressure that result in profit collapses didn’t eventuate through the 2002 to 2007 global economic recovery & look unlikely now economic activity is slowing.What is the risk of a debt deflation spiral?The risk of debt deflation spiral is significant, particularly in the US and UK where house prices are already falling sharply, banks and other financial institutions have sustained big losses with several going bust in the US, bank lending standards have become very tight and may become even tighter as banks’ capital bases continue to come under pressure and the slump in house prices is starting to affect consumer spending.And very poor affordability raises the prospect of something similar in Australia.The intransigence of the European Central Bank which has been raising interest rates despite the sub-prime related credit crunch is also adding to the global risks.However most economic downturns and bear markets go through a period of heightened uncertainty and concerns that the central bank is powerless and is effectively just “pushing on a string” because banks won’t want to or can’t lend and no one will want to borrow. This is a common refrain at some point in most economic downturns and bear markets.And this is pretty much where we are now.More specifically, while there is lots of short term uncertainty and further declines in shares are likely over the next month or so, there are good reasons not to get too bearish:Firstly, the corporate sector in most countries is in good shape and this provides an offset to weakness in the household sector.This is evident in both the US and Australia in the ongoing strength in business investment.Secondly, the US authorities have shown they are prepared to do whatever is necessary to prevent a full-blown debt implosion.They moved very quickly to start cutting interest rates (in fact the Fed started recutting before the US share market peaked in October last year) and provide fiscal stimulus, financial institutions that have run into trouble such as Bear Stearns and Fannie Mae and Freddie Mac have been quickly dealt with and similarly banks in trouble have been taken over by the Federal regulator (12 so far) and their depositors protected. And US banks and investment banks have been quickly dealing with their bad debts.• This is very different to Japan in the 1990s where the Bank of Japan took 18 months after the share market peak to start cutting interest rates, insolvent banks were allowed to linger on, bad debts were not written off until years later and so as a result deflationary forces were able to take hold and this led to an 80% fall in Japanese shares spread over 13 years.• Similarly, the current situation is very different to the US in the 1930s where there was initially a focus on balancing the budget, more than 5000 US banks were allowed to go bust between 1929 and 1933 taking their customers savings with them and in 1931 interest rates were actually increased which all contributed to an 85% fall in US shares over two and a half years.The quick action by US authorities over the last year has been reflected in the fact that the US share market has fallen less (down about 22% from last year’s high) than European, Asian and Australian shares (which are down by more than 30%) so far in the current bear market.Thirdly, the fall in private debt that occurred in the US in the early 1990s in the aftermath of the savings and loan crisis and a commercial property bubble did not prevent economic recovery and a modestly rising share market through most of the period of deleveraging. See the chart below.Finally, it is hard to believe, with consumption being a national past-time, that once interest rates come down sufficiently, Americans and Australians won’t revert to their normal consumption patterns.In this regard, the plunge in the oil price, the ongoing credit crunch and the deteriorating economic outlook will likely see most central banks cut interest rates, including the Fed and the RBA.Concluding commentsFor some time we have been of the view that shares would remain weak into September/October ahead of better conditions later this year and going into 2009. While the ongoing turmoil in the US financial system indicates that the risks have gone up and that shares may see further downside in the next month or so, our assessment is that a long term bear market in shares is unlikely.

IMPORTANT: AIR reports about financial markets and investment products in the widest sense possible. The AIR website and all its contents is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before making any investment decisions.

Markets in the US fell, Asia was lower, and Europe was weak as doubts continued over the US treasury’s $US700 billion bailout plan.The Dow was down 161.52 points, or 1.47%, at 10,854.17. The Standard & Poor’s 500 Index was off 18.87 points, or 1.56%, at 1188.22 while Nasdaq was down 25.64 points, or 1.18%, at 2153.34.Worries about the economy saw the US dollar rise again most currencies, especially the euro and the Aussie which traded around 83.10 US cents, down around a cent in a day.Gold fell $US11 an ounce to around $US897; oil dropped more than $US2.50 to just over $US106.70 a barrel and copper lost 11 US cents to end at $US3.14 a pound in New York.Our market was off more than 1%, according to the overnight futures market and the ASX/200 could start around 70 points down this morning.In new York BHP Billion and Rio Tinto shares were weak as analysts saidf iron ore exporters would get smaller than expected price rises next year.Rio’s American depositary receipts fell the most since at least 1990, losing 13% to $US289.14 and BHP’s ADRs slipped 5.2% to $US61.77.General Electric was the biggest drag on the S&P 500, falling more than 4%, after Goldman Sachs cut the company’s profit outlook. GE’s fall also hit the Dow. GE had itself added to the uS anti-shorting list.Downgrades also hurt Bank of America shares, off 2.5%, while energy company shares fell as the price of oil retreated.More details were made public with US Congressional hearings starting overnight in Washington, but Wall Street didn’t like the debate and delays..Treasury Secretary, Hank Paulson, President Bush and Fed chairman Ben Bernanke all urged Congress to swiftly approve the plan.Chairman Bernanke warned that the US economy would contract if the plan was not adopted and adopted quickly.But there are concerns the Democrats might try to ram through one off pork barrel deals or attempts to control banking salaries, while some Republicans have expressed doubts about the whole idea.Comments from the head of the Senate banking Committee, Senator Dodd didn’t help sentiment.He said this morning government economic rescue plan was “not acceptable” in its current state.”A lot of reservations have been expressed this morning by Democrats and Republicans on this matter,” said Dodd, a Democrat, speaking after Paulson and Federal Reserve chief Ben Bernanke testified in Congress.”What they have sent to us this is not acceptable,” said Dodd. “This is not going to work.”Wall Street tumbled more than 160 points after hearing that, going from being slightly up, to well down on the day.European stock-index futures dropped with Dow Jones Euro Stoxx 50 Index futures off 1.9%National indexes decreased in all 18 western European markets. London’s FTSE 100 lost 1.9%.Asian markets ended the sharp two day rally on those doubts about the Paulson plan.The MSCI Asia Pacific Index (excluding Japan) fell 1.9% with financial shares the big fallers.Stocks fell around the region, except in South Korea, Taiwan and Malaysia. Markets in Japan are shut for a holiday.China’s CSI 300 index dropped 3.8%. Hong Kong was off 3.9%.The Australian share market lost 1.9%, ending the two-session rebound, as doubts grew about whether the $US700 billion ($A840 billion) US financial bailout package would work.The ASX 200 index ended down 97 points, or 1.9% at 4923.5, after rising 4.5% on Monday.Australian shares traded lower as regulators announced exemptions to the ban on short selling and detailed proposed legislation to better control it.At the close the All Ordinaries was down 92.4 points, or 1.8%, to 4957.7.BHP Billiton fell $1.80, or 4.5%, to $37.90, Rio Tinto dropped $2.76, or 2.5%, to $108.24 and Fortescue Metals shed 64 cents, or 9%, to $6.51.Banking led the way down with the ANZ losing $1.11 to $18.04, the Commonwealth Bank 38 cents to $44.22, the National Australia Bank 44 cents to $23.86 and Westpac 20 cents to $24.50.Retailers were mixed, with Harvey Norman adding one cent to $3.51, Woolworths dropping 52 cents to $27.01, Wesfarmers retreating 57 cents to $31.18 and David Jones falling one cent to $4.39 ahead of the release of its full year results later today.Media was mixed, with Consolidated Media Holdings adding three cents to $2.75, Fairfax falling 13 cents to $2.85, News Corp shedding 71 cents to $15.78 and its non-voting shares losing 70 cents to $15.51.Telecommunications provider SP Telemedia lost one cent to 14 cents after reporting a full year loss of $18.93 million following debt write-offs, and cut its earnings guidance for the new year. It’s part of the Washington Soul Patts group whose 61% owned subsidiary New Hope Corp losing six cents to $4.40 despite forecasting significant earnings growth this year and delivering a rise in annual profit to $90.68 millionSantos added 17 cents to $18.70; Woodside dropped a cent to $56.99 and Oil Search lost nine cents to $5.53.The spot price of gold was higher was trading at $US891.30 an ounce by late yesterday, up $US20.15 on yesterday’s local close of $US871.15 an ounce.Gold miners were stronger, with Newcrest adding $1.34 to $26.84, Lihir 12 cents to $2.77 and Newmont 16 cents to $5.15.Telstra was the most traded stock on the market, with 42.05 million shares changing hands, collectively worth $172 million. Its shares rose 16 cents to $3.98.And in a report issued this morning, the International Monetary Fund says Australia is well placed to withstand the credit crunch.In particular, the report notes that IMF “Directors welcomed the support that prudent fiscal policy is providing for monetary policy.”The IMF Executive Board considered that Australia’s banking system remains resilient, with stable profits, high capitalisation and few non-performing loans. This was evident in stress tests undertaken by the IMF and presented in their report, which showed that Australian banks are able to absorb ‘extreme’ shocks.The IMF considers that the outlook for the economy is more uncertain than usual due to large countervailing forces impacting on the economy, with the commodity boom providing a substantial stimulus and the global downturn exerting a contractionary effect. IMF staff forecast that real GDP growth will moderate as required to bring underlying inflation back within the RBA’s target range.On an annual basis the IMF consults with the Australian authorities, private sector economists and academia to provide an independent and comprehensive assessment of Australia’s economic performance. This forms part of its program of economic consultations with all IMF member countries.

IMPORTANT: AIR reports about financial markets and investment products in the widest sense possible. The AIR website and all its contents is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before making any investment decisions.