A tough week for sharemarkets with the big falls on Monday and Tuesday stampeding the US Federal reserve into a bigger than expected 0.75% rate cut which seems to have steadied sentiment and allowed investors some respite.
But these are nervy times.
Share markets have had sharp falls since their highs last year and particularly so far this year. Many are in or just outside being classed as in bear territory: that is, suffering falls of 20% or more than their recent peaks.
Shares though are now great value and will be helped by aggressive global monetary easing over the next 12 months.
But the AMP's head of Strategy, Dr Shane Oliver warns that falls are likely over the next 3 to six months as the US downturn unfolds.
He says that after such sharp falls the best approach for long term investors is to sit tight. For those with spare cash averaging into shares spread over the next six months is probably the best way to play it.
2008 so far has been a harrowing year for investors with sharp falls in share markets amidst ongoing worries about a US recession and its impact on the global economy.
While I started to get pretty concerned about the outlook a few weeks ago on the back of growing concern about the US economic outlook, I must admit to being surprised by the severity and speed of the decline.
The question is what to do now? Should investors park their money in cash or is now a good time to pile back in?
Share plunge
Shares have had falls from their highs last year of 19% in the US, 25% in Europe, 33% in Japan, 25% in Asia ex Japan, 21% in emerging markets and 24% in Australia.
In fact, the Australian share market is on track for its worst January ever, well at least since 1876. It has just ended its longest run of consecutive down days since January 1982, and its 24% fall from its record high on November 1 is its worst slump since a 32% fall between August 1989 and January 1991.
The key driver has been worries about a US recession with a run of bad economic data and continuing credit market woes flowing from the US sub-prime crisis all causing investors to factor in a US recession. Adding to this has been deteriorating news in Japan, Europe and in emerging markets generally.
This has all seen investors throw in the towel on the view that the rest of the world could decouple to any significant degree from the US downturn. The resulting rout in share markets gathered speed to the point where panic selling was starting to become evident.
After such sharp falls, shares are due for a bounce and hopefully the Fed’s move to start aggressively cutting interest rates will help in this regard.
More than just a bull market correction
But after such strong falls it is clear that what we are witnessing is more than just another bull market correction of the sort that we have seen over the last few years.
The rising trend in US shares since 2003 has now clearly broken down, with the S&P 500 now tracing out a pattern of lower highs and lower lows and the 200 day moving average, which provides a good guide to the trend, now falling.
The same is now evident in Australia with the local market breaking below its lows of August last year and the 200 day moving average now falling.
What’s more, many developed country share markets have now had 20% or so falls which is far more severe than anything seen in the last five years. Many see this as signifying a bear market.
Furthermore, the economic backdrop in the US has deteriorated dramatically relative to that during the corrections of the last few years. It’s looking increasingly likely that the US is in recession, profits are falling and credit markets remain in disarray.
So the combination of the change in trend for share markets along with the deterioration in the US and hence global economic backdrop suggests that further falls in shares are likely beyond any near term bounce.
Some perspective
However, while the outlook has become very uncertain and the falls so far this year is painful, several points are worth noting:
Firstly, as far as share market falls associated with US recessions go, there is good reason to believe that the bulk of the damage has been done. The average decline in the US share market associated with US recessions since 1960 has been 30%.
Similarly, in Australia the average decline in the Australian share market associated with US recessions has been 33.8%.
This certainly suggests further falls are possible, but with share markets already having fallen 20% or more a lot of the damage has already been done.
Secondly, 20% plus falls in share markets have been rare in recent years but are not that unusual in a long term context, as evident in the following table for Australian shares since 1960.
While further falls cannot be ruled out and it sometimes takes a while to regain previous highs, 20% plus falls in Australian shares since 1960 have been followed with generally strong returns over the subsequent year.
Thirdly, after such sharp falls share markets are now cheap. The forward price to earnings multiple on Australian shares and global shares are both around 12 times, which is at extreme lows for the last decade.
Australian shares now offer a dividend yield grossed up from frank
