A rough week for everyone, made rougher by some dopey politicians in the US.
Shares made new lows in the past week on more bank failures & uncertainty about the US relief package.
The AMP’s Dr Shane Oliver says that successful approval and implementation of the US debt relief package should head off a worst case economic slump, but won’t stop recession in the short term.
That means the ride for shares is likely to remain rough in the short term, but they are good value on a one year view.
He says the turmoil and recessionary conditions in the developed world highlight the need for much lower interest rates globally including in Australia and Asia.
The credit crunch and global share markets have taken another turn for the worst this week reflecting a combination of continuing bank failures/rescues in the US and Europe and the US House of Representatives initial rejection of the US Government’s debt relief package.
Uncertainty regarding the investment outlook is continuing to drive massive daily swings in share markets.
Over the last twenty trading days the Australian share market has seen 17 days where the market has moved by 1% or more, with US, European and Japanese shares seeing an average of 14 days.
This is way above historical norms.
US economic rescue package and other policy moves
There is no doubt this crisis has turned out far worse than I, or most other investors, anticipated mid last year when it first started to blow up in a big way.
Given the scale of the problems in credit markets and the threat it was posing to the broader economic outlook it is clear a comprehensive solution was needed, hence the US Government’s relief program (now called TARP or Troubled Asset Relief Program).
While a direct injection of capital into banks by the US Government may have been preferable, at least by removing bad debts from the banking system it should go a long way to providing confidence for banks to deal with each other again and for them to be able to raise capital.
As such, while not perfect and certainly not a panacea, the relief program should go a long way to removing the risk of a financial meltdown and hence a long and drawn out economic slump (or depression).
With the package failing to pass its first vote in the US House of Representatives, partly based on misconceived impressions that it was a bailout of Wall Street as opposed to a bailout of the broader economy, money, credit and share markets have simply gone back to factoring in some sort of meltdown.
The gap between bank lending rates and short term government borrowing rates has now reached record levels and the gap between corporate borrowing rates and government borrowing rates has also blown out further.
The likelihood is that some form of financial rescue package will be passed by Congress soon.
The package has now passed the US Senate and with support for the relief package amongst ordinary Americans starting to grow it’s likely that the House of Representatives will vote in its favour soon.
Beyond the mayhem in the US Congress authorities around the world are dealing pretty smartly with banking sector problems by expanding access to liquidity, providing loans to troubled banks, applying and expanding insurance protection for depositors and in some cases actually guaranteeing them.
This is very different to the 1930s when over 5000 US banks failed, taking their depositors savings with them and driving the US into depression.
In addition to this, we think it is only a matter of time before we see interest rate cuts in the US, Europe, the UK, Japan and Asia.
It’s quite possible that these will be coordinated. In Australia, the RBA is likely to cut interest rate again next week with a 0.5% cut now probable given the deteriorating global economic backdrop, the impact of recent turmoil on local confidence, the ongoing constriction in global credit markets and the likelihood that the commercial banks won’t pass on the full amount of any rate cut given the latest blow-out in their funding costs.
The next year for shares
Of course in the very short term a lot is riding on the House of Representatives vote on the TARP. Successful approval by the US would be positive for markets.
Conversely if it fails altogether it will be taken badly. More fundamentally while the US bank/economic rescue program should head off a long and deep recession or depression (providing reasonable prices are paid for the troubled debts) it won’t do anything about the economic deterioration already underway globally.
The US, Europe, UK and Japan are all already on the brink of recession if not in it. China’s growth rate has already slowed from 12% last year to around 9%.
The likelihood of more bad economic and profit news ahead combined with the fact that October is often a rough month for shares indicates that further short term weakness in shares is possible.
But while the short term outlook is unclear it is worth noting that the fall in shares from their highs is now pretty much in line with post 1960 bear markets in terms of magnitude.
The next two tables show bear markets since 1960 for US and Australian shares.
Since 1960 bear markets in US and Australian shares lasted an average 15 months with an average top to bottom fall of 32% in the case of US shares and 34% in the case of Australian shares.
In the current bear market shares have had top to bottom falls of 29% in the US and 33% in Australia, which is similar to bear market average declines.
