The latest edition of our fortnightly email newsletter was sent to subscribers on the 30th of September.
The edition looked at the debt crisis, provided a summary of the bailout efforts of the US government as set out in the proposed Emergency Economic Stablization Act, provided a summary of the movements in markets over the past fortnight and looked at what to do in the current market conditions. If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.
The following is the lead article for the newsletter:
Financial Topic Demystified - Emerging Markets
In this edition of our email newsletter it would be remiss of us, given the extremely volatile market conditions being experienced on investment markets, to avoid discussing what is being widely referred to as the Debt Crisis. Last week we made a presentation to interested clients, via meetings and teleconferences about the current situation.
A copy of the presentation can be found on our Seminar Presentations page on our website.
The following is a brief summary of the discussions.
The debt or credit crisis started with the selling of mortgages to people who could not afford them. They were sold by salespeople on commission. These loans were then sold on to other financial institutions. As such the initial lenders were not worried about the credit worthiness of the borrowers because they were just selling the loans on to other institutions.
Now these loans were non-recourse loans. If the borrower could not pay back the loan the lender could take back the property from the borrower but without any further claim on the assets of the borrower. Property prices have fallen significantly in value so that the value of the assets are now much less than the original loan values.
These loans were bundled together, sometimes with further borrowing, into various products including Collateralised Debt Obligations (CDOs). In Australia some superannuation funds, local councils and banks invested in CDOs.
The problem has now become that no-one trusts anyone in debt markets. If these CDOs can cause an investment bank to fail then no-one wants to lend money to an institution that might have significant exposure to them.
Where to from here?
We do not want to diminish what is happening in any way. This is a very serious financial problem; however there have been others that have gone before. The media enjoys reporting fear and greed which makes it all the more difficult to focus on the fundamentals.
In terms of Australian banks, the banks in the USA that have fallen have been investment banks. Australia's banks are better capitalised, our government's credit rating is AAA and can raise cheap debt if necessary, the Reserve Bank has not had to 'prop up' any institutions and the official cash rate is 7% giving them room to cut rates if growth slows.
In terms of the real economy:
- Unemployment is at historical lows (less than 5%)
- There is no serious expectations of a recession
- The economy is forecast to continue to grow (albeit at a slowing rate - which is not a bad thing in that it keeps inflation under control)
- An International Monetary Fund (IMF) study suggests Australia is well placed to weather the global economic downturn
- Even in the USA the 'real economy' seems to be surprisingly strong, unemployment is reasonable, consumer spending strong - and against forecasts they seem to have avoided a recession up till now (although that may change in the future).
The Bailout which is being hotly debated in Washington (& all over the world), will potentially improve the situation by removing "toxic" debt out of the companies making it easier for companies to "trust" each other and lend and borrow with certainty. Our Fascinating Financial Fact section sets out the details of the plan. However it is not a magic pill and what seems to be really needed is a floor under house prices in the US.
What is already priced into the value of shares?
There is an obvious desire to sell shares, and put the money into cash at such a difficult time. However, the price of shares at the moment must reflect a great deal of fear - from the USA problems and the reporting of this as a 'crisis'.
The value of shares at the moment would likely reflect:
- The probability of a USA recession
- Continued problems in credit markets
- A slow down in company earnings
All this being said, it is a very difficult time on investment markets and a really good time to get in contact with your financial advisor to discuss how it impacts your individual circumstances.