Thanks to the US sub-prime crisis, the oil shock and higher local interest rates Australian shares look like having their worst financial year since 1981-82.
While Australian resources shares have boomed on surging commodity prices, most of the rest of the market slumped on debt concerns and profit worries.
The AMP’s chief strategist, Dr Shane Oliver says shares are oversold and due for a short term bounce, but the next 3 or 4 months are likely to remain rough.
We believe we can expect a strong rebound in the December quarter and better conditions over the next 6-12 months.
"Shares are good value and will perform better as the bad news abates."
Australian shares worst financial year since 1981-82
Short of a surge in the next few days, the Australian share market is on track for its worst financial year since 1981-82.
For the financial year to date the Australian share market is down 14%, against a 32.4% fall in 1981-82 which occurred as the economy slid into its worst post WW2 recession.
Global shares as measured by MSCI are also down 15% in local currency terms (but more in $A terms).
The slump in shares has driven sharp declines in superannuation returns, possibly to their worst financial year since 1987-88 or possibly even the last 25 years.
The big question is whether we will see an improvement over the next year or will shares simply continue to slide.
A “perfect storm”
A year ago, most investment commentators thought that share and superannuation returns would slow after four very strong financial years.
But, apart from the perennial bears, no one foresaw anything like the slump we have seen over the last year. The last year can be likened to a perfect storm for shares and other investments:
• The sub-prime US mortgage crisis led to a credit crunch which led to a collapse in financial shares & companies heavily exposed to debt, and a slowdown in growth;
• The near doubling in oil prices and a sharp spike in food prices pushed inflation and inflation expectations greater pressure; and, more recently,
• Hawkish central bank rhetoric around the world (such as the US Fed now paying more attention to inflation) has removed a leg of support for shares.
This has seen shares fall as investors lost confidence in the outlook, but also as credit dried up and its cost rose.
While Australia has benefited from the surge in commodity prices on ongoing strength in the emerging world the benefit has been largely offset by much higher interest rates as the Reserve Bank has sought to stop a pick-up in underlying inflation.
This is evident in the huge divergence between Australian resources shares (which are up 25% over the last 12 years) and financials and consumer discretionary stocks (which are down 32% and 41% respectively).
Share market volatility has surged as investors were hit by wave after wave of bad news and struggled to determine the outlook.
Over the last year there have been 108 days where Australian shares rose or fell by 1% or more, which is well above the average of 43 days over rolling 1 year periods over the last 18 years. See the next chart.
Reasons to be cautious over the next 3 or 4 months
After big falls since mid-May shares are very oversold and due for a bounce.
The slump in Australian shares has been made worse by tax loss selling into the end of the financial year – when this lifts it will lead to a decent bounce.
However, beyond the potential for a bounce over the next few weeks there are several reasons for caution over the next 3 or 4 months with further share market falls likely:
• we have yet to see the full economic fall out from the US housing slump and credit crunch;
• oil prices remain at a level which is threatening the global and Australian growth outlook;
• in Australia we have yet to see the full economic impact from the rise in interest rates and higher petrol prices;
• given the uncertain economic outlook we are likely to see more earnings downgrades in the next few months;
• the current inflation scare globally and the back-up in bond yields and tougher central bank rhetoric is a headwind for shares in the short term; and
• The May to October period is often difficult for shares & US presidential election uncertainty may not help either.
Expect stronger conditions into year end
However, while the next few months are likely to remain rough it’s probable that shares can remain above their March lows and shares are likely to rally solidly into year end and into 2009.
Firstly, unlike prior to the deep and long bear markets in global shares in 1973-74 and 2000-03, shares were not, and are not now, overvalued this time around.
In fact after recent falls they are now cheap. Global and Australian shares are now trading on lower forward PE ratios than was the case at the end of the last bear market in March 2003. Australian shares are trading on 12 times which is their lowest since 1995 and compares to a ten year average of 15.2 times.
Global shares are trading on a forward price to earnings multiple of 12.2 times compared to a ten year average of 17.4 times.
As a result, the Australian share market is trading below the bottom end of its fair value range. See the next chart.
