• BT Financial Group
• Westpac

Associates

• Regnan

Watch the BTIM investment team present their views on current market conditions and the outlook for investors.

18 January 2008: So far this year, the Australian share market is down by
about 11%. Contributing to this fall was the news on Wednesday that Citigroup,
one of the world’s largest financial institutions, had announced a larger than
expected US$9.8 billion fourth quarter loss as a result of write-downs linked to
the US sub-prime mortgage market. This led to a major sell-off on Wall Street
which was subsequently felt around the world, including here in Australia
where the local market lost more than $30 billion of value in one day.

A continuation of recent market volatility

What we’ve seen so far in 2008, in our view, is arguably a continuation of the
market volatility that we’ve seen in global investment markets over the last year
or so. The problems in the US sub-prime mortgage market are well known, but
we think the fallout from these problems has yet to be fully realised. This has
created a great deal of uncertainty amongst investors already concerned with
the threat of a possible US recession, so it’s perhaps not surprising that the
market reacted the way it did this week to Citigroup’s announcement.
Unfortunately, no one can say with any real confidence just how deep the
problems in the US sub-prime mortgage market really are, so it’s possible we
may yet see more losses from other major banks in the near-term which could
result in further sell-offs in global share markets.
Another factor that’s been weighing heavily on global share markets in recent
months is the threat of a recession in the US. The housing market in the US
remains very weak and this has only been exacerbated recently by a string of
softer economic data and the ongoing problems in the sub-prime mortgage
market. Some economists have put the chance of a recession in the US at
50%, but we think this is probably a little overdone. We actually believe the
chances of a serious recession is less likely than the consensus view would
suggest, however, if it were to happen, we would expect it to be short-lived,
with most of the companies we invest in from Australia bouncing back pretty
quickly.

What does all this mean for Australian investors?

The upshot of all of this is that market volatility is becoming more and more
common, so bigger market swings are something that we believe investors will
have to get used to. Just a few months ago, the Australian share market
underwent a similar correction, though that proved to be short-lived after the
US Federal Reserve came to the party and eased interest rates. That had a
positive effect on global share markets and we think the same will happen this
time around.
However, we do believe it’s inevitable that rising market volatility will have an
impact on future investment returns. The Australian share market has posted
strong double-digit returns each year for the last four years, but it’s unlikely that
we’ll see similar returns again in 2008. That said, we don’t believe we’ve come
to the end of the ‘bull’ market that began back in early 2003, so we do still
expect returns to be positive.
In terms of interest rates, we think the Reserve Bank of Australia (RBA) has
some room now to wait. A month ago, we would have expected another rate
rise in either February or March, but given what’s unfolded recently, we think
Market Update
the chance of a rate hike has faded somewhat. We’ve already see evidence
that China – the main driver of our economy – is beginning to slow, and that
will take some of the pressure off the RBA to lift interest rates further. And
that’s perhaps the good side to this story – that Australia has got a different
economic cycle to the US, meaning we no longer have to dance to their tune.
We now have a more independent economy, more linked to a variety of
markets, particularly Asia. So while a slowdown in the US won’t be enough to
force Australia into recession, it will take some of the heat out of our economy
and potentially leave interest rates more stable.

BT’s strategy to combat market volatility

In this volatile environment, we will continue with our strategy of focusing on
companies that have secure cash flows, limited expectations in their valuations
and sound management teams. We believe there are enough pockets of good
value in the Australian market to remain invested and we actually think the best
stocks in the market at the moment are probably those that have fallen off the
radar; mainly good quality companies that aren’t held hostage to what’s been
happening in the US and the rest of the world.
As an investor, we believe it’s important to remain focused on your long-term
investment horizon, and not get too caught up in short-term market
movements. There have been plenty of major market events over the last
twenty years that have hurt share markets, but they inevitably bounce back
with time. It’s also important that you consider the benefits of seeking
professional advice around your own investment needs, and protect your
investments at all times with a well-diversified portfolio.
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