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Saturday 15 November - ABC Radio material

The Four Factors Weighing on Share Markets

I have tried to identify the progress of four factors that I see negatively impacting on the share market at the moment.  It should be noted that understanding what is happening in investment markets at any time is a tremendously difficult (perhaps impossible) challenge - so these remarks should not be seen as anything more than a guide, or some general thoughts.


Factor 1: The Credit Crisis - (or the debt crisis) - borrowing rates in key debt markets continue to ease.  This is a positive sign: although we should always keep in mind that it has taken significant Government intervention to make this happen.  Kevin Rudd, Malcolm Turnbull and Lindsay Tanner have all make tentative comments that the worse of the credit crisis may be behind us.


Factor 2: Recession Fears - a recession is two negative quarters of economic growth.  The USA and Germany recorded their first quarter of negative growth (to end September) - so a recession is likely to have started there and to be 5 months underway.


In Australian forecast growth rates have been cut to between 1% to 2% for next year.  A business confidence survey out this week was very negative; a consumer confidence survey reasonably positive.  Let's face it - 6 months ago all consumers wanted was lower interest rates and lower fuel prices.......


Employment figures were OK, with an increase in part time jobs offsetting full time jobs - however job adds as leading indicators of employment have fallen.


The interest rate cuts (200 basis points thus far) and the December stimulus policy are the policy maker's attempts to keep Australia out of a recession.


Factor 3: Forced Selling/Fear Selling - Suggestion from a hedge fund manager (reported on CNN Money in the USA) that the forced selling from that part of the market was more than halfway done: however this is hard to quantify.  The 'vix index'(in the USA), measures volatility and is sometimes known as the fear index.  It's currently at 59.  Its high for the year has been 89.5 - 59 is still considered high.


Factor 4 'wildcard' - USA house prices - (if house prices stabilise then the mortgage securities that the banks/financial institutions own will have a known value which potentially help).  There has been talk about Fannie Mae and Freddie Mac and other institutions (Citigroup) crafting plans to help USA mortgage holders - this is a reasonable sign.   Data on homes for sale in the USA shows the number for sale is very high (October data); but declined by 1.65% from the previous month.  There are 4.3 million homes for sale (10 months supply).  Foreclosures remain very high.


The Role of Interest Rates

Interest rates are a current issue, with the Reserve Bank of Australian cutting them by 200 basis points from 7.25% to 5.25% over the past three months.


The political agenda of recent times has focused on the mantra that low interest rates are good interest rates.


However that may not be the full story.


Interest rates are like the brake or accelerator that the Reserve Bank tries to use to keep the economy growing nicely - and the prices of goods and services rising slowly, but not to slowly (between 2% and 3% a year is the target).


Higher interest rates are often reported as being a negative - creating higher mortgage costs for home owners.  However, there are many people who have cash and term deposit investments, who receive a higher return on their investments when interest rates are high.


It is worth comparing Australia and the USA in the current difficult financial crisis.   Because Australia had higher interest rates at the start of this difficult time financially, there is greater scope for the Reserve Bank of Australia to cut interest rates and increase economic activity in Australia.  The USA does not have this capacity.


As the Reserve Bank decreases interest rates money becomes cheaper for households and businesses to borrow - so they are more inclined to borrow and spend (or invest).  Also, households with debts (for example a mortgage) spend less money for the interest on their loan, and have more money to spend on other items.

The Difficulty of Forecasting

The following forecasts are from the 'Age Economic Survey 2008'.  There are 28 economists surveyed.  Their predictions were that by the end of 2008 markets would close between 4500 (most pessimistic) and 7650 (most optimistic).  The average forecast was for the ASX 200 to be at 6856; which would imply a gain of 8.1% from growth, say 4% from dividends, a total return of 12.1%.  (very much the long run average return from share markets).


Markets look likely to close the year below that range.


Interestingly, the highest forecast is the forecaster from Lehman Brothers - so not only is he the most wrong, he is out of a job now that his firm has collapsed.


Currency forecasts for the end of 2008 were for a currency between 77 cents to 95 cents: average 90 cents.  Again, everyone is looking like they will be wrong.


The lesson (I think) is not to be too focused on forecasts; and certainly not to follow them blindly.


When these forecasts were made, we knew about the 'sub prime crisis' - it's just that none of these forecasters got the extent of the crisis correct.