Australian share market dips again
Dirk Morris, CEO BT Investment Management
In recent weeks we’ve all watched the Australian share market take another significant hit, down 6% so far in June and 15% since the start of 2008. Here, BT Investment Management CEO Dirk Morris takes a look at what’s behind the latest dip in the local market.
A shift in thinking
The recent dip we’ve seen in the Australian share market stems largely from a shift in the thinking of the world’s central banks in relation to the outlook for interest rates. You’ll remember that earlier in the year there was some concern the ‘credit crunch’ and a weakening US economy would lead to a significant slowdown in global growth. Share markets everywhere, including our own, tumbled as investors fled riskier assets in favour of the relative safety of government debt.
However, the outlook for global growth has arguably turned out better than we’d anticipated, helped along in particular by strong demand for commodities from emerging markets such as China and India. Unfortunately, though, this demand for commodities has only exacerbated the upward trend in commodity prices, especially oil, and put inflation firmly back on central banks’ radars. And this is really what’s driven the shift in thinking on interest rates.
Where central banks had previously been concerned with global growth (and either cut or left interest rates on hold as a result), they now seem more focused on the threat of rising inflation. And the only way to combat rising inflation is to raise interest rates. Of course, when interest rates rise, so too does the cost of capital, and this is what has caused investors to re-evaluate, or re-price, the outlook for funding, despite the fact there are still signs of underlying economic strength both here and overseas.
So, in a nutshell, the sell-off in the Australian share market in recent weeks has come about mainly because of concerns that our own Reserve Bank may be forced to raise interest rates in the latter half of the year. And these concerns have already been reinforced by comments from a number of Reserve Bank officials, including Governor Glenn Stevens, which have hinted that further interest rate hikes cannot be ruled out should the domestic inflation outlook begin to deteriorate.
The outlook for Australia: where to from here?
The Australian share market has now given back most of the gains it made since its lows back in mid-March and could remain volatile in the near-term.. However, we’re comfortable that this latest sell-off is temporary. By raising interest rates to contain inflation, central banks are, in fact, doing the right thing. Once that job is seen to be complete – which we don’t think will require much in the way of interest rate rises – and commodity prices begin to stabilise or even come back down, we should see the local market recover.
The interest rate outlook here is nowhere near as favourable as in places like the US or Europe in the sense that we’re starting from a much higher base (7.25%). On top of that, we expect the Australian dollar to remain at very high levels, which will continue to make it difficult for the export sector (outside of resources).
The extent of the impact of leveraged financial companies also continues to worry us and the news in the last week or so of the issues surrounding Babcock & Brown is just another sign that our economy has perhaps relied too much on ‘leverage’ – at least more than some other economies anyway.
Where should investors look for value?
In current market conditions, we favour US and Asia stock markets and, in Australia, resources stocks over companies within the leveraged financial space, such as listed property and diversified financials.
One area beginning to look more attractive, though, is credit markets. Liquidity in credit markets has certainly improved, boosted by the deal between Westpac and St. George Bank, and we now see some real opportunities for investors in this space.
What can investors do to help lessen the impact of volatility?
Current market volatility is really just an extension of the volatility we talked about back in January and we expect it to continue for some time yet. In this environment, we believe it’s important for investors to stay focused on their long-term investment horizon and to try to maintain perspective. So far this year, the Australian share market is down 13.9% but it still delivered strong long term performance. It’s also important that investors consider the benefits of seeking professional advice around their own investment needs, and protect their investments at all times with a well-diversified portfolio.