The Fed’s latest move to combat the credit crunch has set off a short-covering rally in share markets, although so far it’s looking rather shaky. Yesterday it turned into another bear trap here with a savage day on the market with a 2%-plus fall.
The AMP’s Dr Shane Oliver says that while it’s possible we may have seen the lows in share markets, it’s likely that more downside lies ahead in the next few months as the news on the US economy is likely to get worse before it gets better.
Share markets have had terrible falls since October/November last year. This has thrown up a whole bunch of questions. Why have Australian shares fallen more than US shares? Will the Fed’s latest attempt to counteract the credit crunch work? Have we hit bottom?
If not, then when? And why, what with all the problems around, won’t the bear market be long and drawn out?
There’s a bear in there (and it’s not Play School)
After stabilising from late January till late February, share markets took a turn back down into early March. This saw several markets, including the US and Australian share markets, fall below their January panic lows confirming that the pattern of falling lows and falling highs (which defines a bear market) remains in place. See the next chart.
What’s more, the 200 day trailing moving average of share prices for both markets is still falling, providing further evidence that the trend is now down. This confirms that the situation now is far different to the modest corrections that share markets experienced during the bull market from March 2003 to late last year where markets quickly rebounded and a rising trend always remained in place.
The key drivers of the bear market in shares include: • continuing bad news on the US economy; • ongoing problems in credit markets with the whole securitisation process (whereby individual loans are packaged up into securities) that has underpinned a lot of credit growth in recent years now in disarray, and the banks unable to take up the slack; • increasing worries that the US downturn will spread globally – with the slump in US employment confirming that the US downturn is likely to spread into consumer spending which in turn will have a big impact on Japanese, European and Asian exports; and • ever higher oil prices – there is an old saying that the oil price will keep rising until “it kills demand” and that certainly seems to be what’s happening now with oil prices now disconnecting from slowing global oil demand and being increasingly propelled by speculative activity.
Higher oil and petrol prices will only tighten the screws further on US consumers already reeling from falling house prices and falling employment and Australian home borrowers under stress from high interest rates.
Why have Australian shares fallen more than US shares?
From their high on November 1 to their low earlier this week Australian shares have fallen 25%. By contrast US shares have had a 19% fall. This may seem surprising given that all of the problems are supposedly in the US. Several factors explain the greater fall in Australian shares:
• Australian shares rallied harder out of the August low last year on expectations that global growth would hold up and hence they became more vulnerable to a fall;
• many Australian sectors including banks were trading on higher price to earnings ratios than US sectors again making them more vulnerable;
• the fall in the $US has been helping US companies but the rise in the $A has been harming Australian companies; and finally
• whereas the US has been cutting interest rates providing a source of support for US shares, the RBA in Australia has been raising interest rates.
In fact, it is interesting that in countries where interest rates have fallen in the last six months (such as the US, UK and Canada), top to bottom share price falls have been milder (with falls of 19% in the US and 17% in the UK and Canada). But in countries where interest rates have been on hold or rising such as Europe, Asia and Australia share prices have come off by more (with falls of 23% in Europe and 25% in Asia and Australia).
Our valuation indicators show that Australian shares are now cheaper than global shares. But this may take a while to be realised, particularly with the impact of higher interest rates still hanging over the Australian economy and shares.
Will the Fed’s latest efforts work?
In the last week the Fed and other central banks have been stepping up efforts to counteract the credit crunch. The Fed has made more money available for cheap loans to US financial institutions and will lend out $US200 billion of Treasury bonds for 28 day periods to US banks against high rated but out of favour mortgage backed securities that cash strapped banks can in turn lend to other firms in return for cash.
Quite clearly, the Fed is pulling out all stops to stabilise the mortgage backed securities market. However, the amount involved is relatively modest (compared to $US2.4 trillion of non-prime US mortgages) as is the 28 day loan period, so more action by the Fed will be required – maybe the Fed will actually have to start buying the so called “toxic debt” off the banks (but this involves all sorts or moral hazard and monetary policy issues).
Furthermore, the latest actions don’t do much to restore investor confidence in the broader US credit market. And they won’t prevent a further fall in U
