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Markets continue to cause havoc

November 2008

The past month has left many investors feeling bruised and battered. The seemingly relentless decline which has seen the Australian share market halve from its levels in 2007, has also made significant inroads into many peoples’ retirement savings.

Recent weeks have been especially difficult. On 20 November, the previous 11 trading days saw almost 1,000 points written off the ASX 200 Index. This represents a 23 per cent fall.

Factors which have contributed to this decline on the Australian share market have been a weakening domestic economic outlook and uncertainty surrounding efforts to stabilise global banking systems. An about turn that occurred in the past month was the US Government’s announcement that it would no longer acquire distressed mortgage-backed assets as was initially intended under its $US700 billion Troubled Assets Relief Program (TARP). The decision to amend the TARP was due to difficulties in determining a true value for Mortgage Backed Securities (MBS) assets. It will instead utilise this money to acquire direct equity stakes in troubled financial institutions.

Companies which have suffered the most have been those that carry relatively high levels of debt. This has tended to include listed property trusts and listed infrastructure. Many of these companies have had to rely on shareholders for capital as they have been unable to sell assets at an appropriate price in order to reduce debt. This process of paying down debt is referred to as ‘de-leveraging’. Companies are no different to many individuals in the sense that just as individuals are generally content to ‘gear up’ when times are good, they are often just as averse to carrying leverage when times are bad – particularly when there is a perception, among some, that things are just going to keep getting worse.

It would also come as no surprise to you that many margin loan providers have been making record numbers of margin calls over October and November. These have added yet more downward selling pressure to an already battered market.

In an illustration of just how much bad news is priced into markets, Macquarie Bank unveiled a profit for the half year which was 43 per cent below the corresponding period a year earlier. Instead of the announcement being met by a significant sell down, as many had anticipated, the stock rallied sharply. The message that could be taken from this is that while the news was bad, it simply wasn’t as bad as markets had expected.

As a further example of the divergence in views, the Reserve Bank Australia (RBA) expects Australia’s GDP to grow somewhere in the region of 1.5 per cent for the 2008 calendar year. This contrasts with valuations on the share market which appear to be pricing in a severe recession. These conflicting messages make it difficult to determine what direction markets and investors may take.

However, it is likely that it will take some time for positive sentiment to return to the market. But this doesn’t necessarily mean that you should depart from your long term investment strategy.

Switching your assets to a defensive position may be tempting during these uncertain times, but it is important to recognise that any changes you make now may have an impact on your investment returns when markets recover. It is also difficult for anybody to time their re-entry into the market. This is the time to stay informed and make sure you have access to good financial advice.