Dr Shane Oliver
AMP Capital
Chief Economist and Head of the Investment Strategy team
>The malaise in financial markets is continuing with Australian shares now joining Europe, Japan and emerging markets in a bear market.
>Global growth worries could drive more short term weakness. But in the absence of a US/global recession it’s hard to see a deep and long bear market.
>The key for investors is to recognise that periodic declines in share markets are normal, that selling after big declines just locks in a loss, that dividend income from a well-diversified portfolio is little affected by share market volatility and that income flow from Australian shares is now very high relative to bank deposits.
Introduction
The malaise affecting equity markets and risk assets generally has shown no let up with Australian shares slipping into bear market territory yesterday (defined as a 20% or greater decline from the most recent high). In some ways it is reminiscent of 2008 with tightening credit markets, bank shares under pressure and worries central banks are powerless.
From their highs last year to their latest lows US shares have now had a fall of 13%, Australian shares -20%, Japanese shares -25%, European shares -26%, Emerging market shares -27% and Chinese shares -49%. So Australia is not alone – in fact the drivers of the fall from last year’s high are global and many markets have had deeper falls. With global growth worries likely to linger we could still see more downside in the short term. However, a critical differentiator between whether that further downside is say 5-10% and short versus say another 25% and drawn out is likely to be whether the US/global economy has a recession and whether central banks can provide more helpful policy support.
Fault lines in the global economy
What started in January as mainly China based worries has clearly broadened back out to concerns about global growth. At its core there are five fault lines running through the global economy. The first is the malaise in emerging markets that began earlier this decade, with Brazil and Russia in recession. The second is the ongoing concern about China and its intentions regarding the value of the Renminbi. The third is the collapse in commodity/oil prices which is weighing on energy producers and hence business investment, credit markets and driving selling by sovereign wealth funds. The fourth is the strong $US which has made the fall in the oil price worse, raised debt servicing concerns in the emerging world and weighed on the US economy. Finally, there is fear itself as financial market turmoil drives fears that this will cause a global recession (via reduced confidence, lower wealth and tighter credit conditions) which in turn is reinforcing selling pressure and pushing share markets even lower. Worries about banks – and their exposure to energy loans & higher bad debts if there is a recession – seem to be at the centre of this.
These are all feeding on each other to a degree. However, there are some positives: Chinese economic data has been more mixed rather than negative lately; the Renminbi has settled and the $US looks to have peaked; and central banks are becoming more dovish. But I think there are three key issues. How serious is the problem regarding banks? Will the US have a recession? And are central banks out of ammo?
What is the risk of another bank crisis/credit crunch?
While the risks have risen, there are several reasons for believing that a GFC style credit crisis is unlikely. Banks are better capitalised now, US and European bank exposure to energy loans at around 2-4% of total assets is a fraction of their exposure to housing loans (at the centre of the GFC), new restrictions on proprietary trading have limited banks’ exposure to riskier corporate debt and the issues of low transparency and complexity that bedevilled the sub-prime mortgage market are not really an issue in corporate debt markets now. So far we are not seeing any blow out in interbank lending rates.
Is the US economy headed for recession?
This is a critical question as the US share market sets the direction for global shares including the Australian share market and the historical experience tells us that slumps in shares tend to be shallower and/or shorter when there is no US recession and deeper and longer when there is (eg the tech wreck and GFC). See the next table.
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