Markets update: Australian share market dips again

23 June 2008

In recent weeks we’ve watched the Australian share market take another fall after solid gains in April and May. With some major share market movements already behind us, we look at what’s caused the latest dip in the local market.

The -6.3%¹ fall in the Australian share market since the start of June stems largely from concerns about rising inflation – and how central banks around the world choose to contain it.

You’ll remember earlier in the year central banks were concerned that falling US house prices and a slowdown in the US economy would lead to a slowdown in global growth. Based on this view, share markets everywhere dropped as investors moved away from ‘growth’ investments – like shares, which rely on growing, not slowing, economies – in favour of more stable investments, like cash and government debt.

Since then, the outlook for the US market and global growth have both improved beyond expectations.

Emerging markets like China and India have also added to a more favourable outlook by continuing to create strong demand for commodities, especially oil. While this is good news for Australia’s resources sector, the flipside is that the increased demand for commodities has led to an increase in commodity prices. And higher commodity prices mean more money pumped into the Australian economy – pushing local inflation higher.

A change in thinking: is inflation now the key?

What this means is that the ongoing concern for the Reserve Bank of Australia (RBA) is no longer just US and global growth, it’s also inflation – and how to control it.

One of the most effective ways to contain inflation is to raise interest rates, or raise the cost of borrowing money. In Australia, there is a growing sense that inflation isn’t under control, and that the RBA will be forced to raise interest rates in the next six months.

When interest rates are expected to rise, investors and markets generally re-evaluate the outlook for funding, company profits and market growth based on their new interest rate expectations. This sometimes results in a temporary fall in markets, as we saw mid-June.

Where to from here?

This temporary fall has seen the Australian share market drop back to where it was in mid-March, and there could be more swings in the near-term. However, given inflation is the main influence behind the latest market movements, we’re comfortable the market drop is temporary.

Once the RBA is satisfied inflation has been contained – which shouldn’t require too many interest rate rises – and commodity prices begin to stabilise, we should see the local market recover.

The outlook for Australia

Having said that, there are a number of factors that will play a big part in how soon we start to see a recovery:

Australian interest rates (7.25%) are much higher than in places like the US and Europe and there’s a chance of more rises over the short-term.
The Australian dollar will remain at very high levels compared to other currencies, which will continue to make it difficult for the export sector (outside of resources).
The extent of the impact of financial companies which have borrowed heavily and are now under some distress continues to be a worry. The fall in share price for Babcock & Brown is just another sign our economy has perhaps relied too much on ‘borrowed money’ – at least more than some other economies anyway.

Where should Australian investors look for value?

In current market conditions, we think US and Asian stock markets and Australian resources companies offer some good opportunities. The amount of easily available money – or liquidity – in credit markets has certainly improved and we also see some real opportunities in this space.

What can investors do to help lessen the impact of volatility?

Current market fluctuations are an extension of the volatility we talked about back in January and we expect it to continue for some time. In this environment, we believe it’s important for investors to stay focused on their long-term investment goals and to maintain perspective – markets do fall, but they also rise.

So far this year, the Australian share market is down 15%, but investors have still benefited from strong returns over the long-term. In this environment, it’s important to consider the benefits of professional advice built around your own investment needs, and continue to protect your investments with a portfolio covering a wide range of asset classes – like international and Australian shares, property funds, bonds and cash.

1. Australian share market close of trade on Monday 23 June 2008, measured by the S&P/ASX All Ordinaries Index.

Important information

Any advice and general education information contained in this document is of a general nature only and does not constitute personal financial product advice. In preparing the advice no account was taken of the objectives, financial situation or needs of any particular person. Before making any investment decision, readers should therefore consider the appropriateness of the advice with regard to their particular objectives, financial situation and needs. Although the information contained in this document was obtained from sources considered to be reliable, FMD Financial does not guarantee that it is accurate or complete. Therefore readers should not rely on this information when making investment decisions.