Below are some key events that have occurred over recent months. While there were some indications that the rate of decline had at least started to slow and in some cases even started to recover, further surprises and corporate disasters have continued to emerge.
• The 2008 calendar year to date has been one of the worst in recent history with most major global sharemarkets experiencing declines. In early April, the market was positive and saw a slight recovery, with global markets rebounding between 4.5% in the US to 12.7% in China. Since then, however, most markets have continued to fall each month. On September 15th the US market lost 4.7% in one day. However, this was followed by an increase of 1.75% the next day. For the calendar year to date the Australian sharemarket (S&P/ASX 200) has declined by 25% while the US sharemarket (S&P500) has fallen 17%. For the Australian sharemarket, the peak for the calendar year to date was 1 January 2008, whilst September 16th has represented the lowest point this year to date.
• Following on from the near collapse of US investment bank Bear Sterns a few months ago, within the last week some key developments have occurred:
- Lehman Brothers Holdings Inc - the fourth largest US investment bank filed for bankruptcy on September 15th as rescue talks over the weekend were abandoned. The 158 year old investment bank has collapsed as a result of the credit crisis and falling real estate values in the US and has filed the biggest bankruptcy ever.
- Freddy Mac and Fannie Mae - are participants in the secondary mortgage market in the US. They were involved in buying mortgages from the banks, guaranteeing the repayments and selling this as mortgaged backed securities to the market. In 2008 Fannie Mae and Freddie Mac effectively owned or guaranteed about half of the US$12 trillion dollar mortgage market. Essentially, Freddy Mac and Fannie Mae were both highly exposed to the US sub-prime mortgage crisis. It required unprecedented US government intervention to prevent the collapse of both corporations. Some economists held the view that both companies should be allowed to fail but the US government believed intervention was necessary for the stability of the US financial system.
- Merrill Lynch - Bank of America is buying the Wall Street investment banking icon for about $US50 billion in an all stock deal that creates the world’s largest financial services company, rivalling Citibank. Bank of America has the most deposits of any US bank, while Merrill Lynch is the world's largest and most widely recognised brokerage.
- American Insurance Group (AIG) - is the largest international insurance organisation. On the same day as the Lehman Brothers and Merrill Lynch announcements, AIG advised they were in trouble and were seeking emergency capital injection. AIG was seeking a loan for approx $US75 billion to keep it from declaring bankruptcy. At the time, the US Federal Reserve declined to assist and asked other well known investment banks to help. However, on September 16th, the Fed finally stepped in to assist AIG with an emergency loan, allowing AIG to avoid bankruptcy.
• Daily sharemarket fluctuations as much as (+/-) 3% have been a common occurrence.
• Relative to the US, the Australian economy appears to remain in a better economic position on the back of a strong resources sector. However there have been signs of growth slowing in the first half of 2008. The Australian economy grew at an annualised rate of 2.3%, which is down from 3.7% in the second half of 2007. Commodity prices have deteriorated of late and resource stocks have retreated. One key driver will be whether demand from China continues.
US
• Since the beginning of 2008, US sharemarkets have continued to fall as crude oil prices hit another high of US$147.27 per barrel on July 11th but have since receded as reports of reduced demand and encouraging statements from OPEC took hold. As at midday September 17th, the oil price was US$91.49 per barrel.
• In January, Ben Bernanke (Chairman of the US Federal Reserve) acknowledged the outlook for economic growth had worsened and that the economy was weak enough to need stimulus, with interest cuts ensuing. The Federal Reserve slashed key interest rates by 0.75%, bringing the Federal Fund rate to 2.25%. The Federal Reserve has since remained on hold and GDP growth grew by 0.6% in the first quarter and 3.3% in the second quarter, revised up from 1.9%. While these figures are encouraging there is still the belief that GDP growth will again fall in the coming quarters. Despite this, the Federal Reserve left rates on hold at their September 16th meeting.
• The financial sector globally continues to bear the brunt of the “credit crunch” as major banks such as Lehman Brothers and Merrill Lynch continue to announce the news of sub-prime related write-downs to their financial statements.
Whilst the rest of the world is still faring better than the US, the downturn continues to impact growth around the world.
Australia
• Australian economic conditions remain relatively positive but are continuing to be influenced by events occurring globally, particularly in the US. Most of the Australian economic slowdown is concentrated in the household sector, with consumption falling for the first time since the September quarter of 1993. Put simply, people aren’t spending as much as they used to.
• The early 2008 interest rate rises in Australia have slowed economic growth markedly in recent months.
• Economic data for Quarter 1 2008 and Quarter 2 2008 has been mixed but overall economic growth has still been expanding, albeit at a slightly reduced rate. Employment has remained relatively buoyant although there are early signs that some weakness may be occurring. The Consumer Price Index (CPI) has remained above the Reserve Bank of Australia’s (RBA) target range, primarily due to higher fuel and food prices. However, the RBA is expecting the CPI to move back into the 2 -3% target range by late 2009 - early 2010 and recent data supports this view. Business confidence has taken a hit and business conditions have dropped below their long-term average level. Business conditions and business confidence measure how businesses have been and how they think they will perform in the future. As a result of this evidence of weaker economic growth induced by the previous increase in interest rates, the RBA cut rates by 25 basis points in early September, 2008. Given the extent of the slowdown, further rate cuts are anticipated by mid 2009 with a reduction before the end of this calendar year.
• The Australian sharemarket has been in a bear market since November 1, 2007, declining 30%. There most severe declines have been felt in the more highly leveraged Property, Infrastructure and Financial Services sectors. Through this year, the global credit crisis has placed extraordinary pressure on the financial sector, impacting the cost of funds for all major Australian banks as well other finance groups. The Australian banking sector has been impacted by the fallout from the sub-prime issues with write-downs on their sub-prime exposure impacting the broader financial sector. While we have seen some cuts to variable home loan rates, medium and long-term credit rates are still high, which means it is still expensive for banks to find funding and further rate cuts from banks remain an uncertainty in the near term.
• Over the last 15 years ending August 2008, the Australian sharemarket (S&P/ASX300 index) has delivered approximately 11%p.a. returns for investors. The expected forecast return over the next 5 years for the Australian sharemarket is around 9%p.a. This does not mean that each year investors will get 9% - there will be volatility and negative returns over this period and 9% is the expected average annualised return. The Financial Year 2008 Australian company reporting season results were largely in line with expectations, and reflected the divergent results of companies across the Australian economy. However, company management outlook statements have generally been cautious although largely reflected or “priced in” by the market.
• The Australian dollar has been extremely volatile over the past few months. Having almost reached parity with the US dollar (US98.49 cents), the A$ has fallen approximately 20% to the US79 - 80 cent level in the 8 weeks since mid July 2008.
• Previous communication highlighted that the performance for the Australian sharemarket had been driven mainly by the Financials and Resources sectors. These sectors make up over half of the Australian sharemarket. With the recent significant declines in Financial stocks (mainly due to uncertainty caused by the US sub-prime crisis), it is no surprise that the Australian market has declined given that Financials make up a large proportion of the Australian sharemarket. This has continued and year to date (as at September 16th) the Financials sector had declined by 33%. In addition, the Listed Property market (S&P/ASX 200 A-REIT Index) has fallen 33% while the Resource sector has declined by 19%.
