Dirk Morris, CEO, BT Investment Management
When the history of this credit crunch is written, it may be that the bail-out of Bear Stearns marks a turning point. Bear Stearns was one of many US financial institutions that used large amounts of debt to generate returns in areas such as hedge fund management and mortgage securities trading. Now that credit has dried up, they’re paying the price for having a business model too reliant on easy credit conditions.
By arranging the sale of the company, the US Federal Reserve (the Fed) has removed another source of instability from US financial markets. We expect the Fed will now act even more aggressively to ease the credit squeeze. Where possible the Fed has been working with other Central Banks to improve the situation. Given the globalisation of financial markets this co-ordination is vital to restore overall market confidence. So far, however, the European Central Bank (ECB) has been reluctant to get on the band-wagon, but we now expect to see lower interest rates in Europe as well. Indeed European interest rate cuts at some point in the next few months could be the crucial last piece of the policy puzzle – the piece needed to turn market sentiment in a more positive direction.
If the ECB does get on board we believe it could herald a return to better global sharemarket conditions. We see a number of grounds for this belief:

• At current levels, global equities are priced as if a serious recession was inevitable. If we get broad Central Bank co-ordination, that recession risk is likely to fade, markets will reassess the business outlook and share prices should rise.
• Because there is little or no inflation threat Central Banks have plenty of room to move. Just as importantly, the absence of an inflation threat is always a positive for share investors with a medium term view.
• The income returns from international shares are increasingly attractive, another factor likely to bring buyers back to the market.

The Australian landscape
The story in Australia is a little more nuanced. Our economy has enjoyed a huge pay rise from the boom in Asia and that’s created inflationary pressures the Reserve Bank of Australia (RBA) wants to moderate.
As a result Australia is caught between conflicting forces. We have a global credit crunch which means most other countries are looking to cut rates. Yet the strength of our economy sees the RBA grappling with the need to push rates higher to cut inflation.
That makes predicting events a little harder in Australia and is one of the reasons we’re more positive on international equities than Australia companies in the short-term. However, markets are already pricing in a pause in the RBAs rate hike run and it would be no surprise to see rates fall in the second half of this year.
There is good news for long term Australia share investors:

• There’s been a lot of short–selling in the Australian market. This short-selling will have to be undone if global conditions improve and share prices should bounce as a result.
• Australia will also continue to benefit from the continuing urbanisation in China and India. That’s driving productivity increases throughout the region, boosting the performance of our big miners and underpinning Australia’s growth rates.
• The income return from shares (especially when you factor in dividend imputation) is now much more attractive than that from bonds. That should also boost Australian share prices in the medium term.

Stick to a strategy
Make no mistake, investment markets are very volatile and likely to stay that way for some time. Yet it’s in times like these that sticking to a planned investment strategy becomes more vital. If you’re invested for the long term – especially through superannuation – there may be buying opportunities you can profit from.
In our own portfolios we’re favouring companies with low debt and what analysts call highly visible earnings. We want to own companies that have reliable, proven income streams and whose earnings performance is easy to monitor.
In this environment individual investors will also benefit from avoiding companies with big debt levels. As ever, it’s important to maintain broad and intelligent diversification.
© BT Investment Management 2008