Herd Tramples Over Facts On The Ground
Sydney Morning Herald
Thursday January 24, 2008
THE reason that stockbrokers and economists cannot explain why the stockmarket plunged more than 7 per cent on Tuesday and rose more than 4 per cent yesterday, and cannot tell you with any certainty what it will do next week, is because the market does not always respond to fundamentals and it is not necessarily rational.
They have a series of facts but how the investment herd interprets them will determine how the markets will behave. Fact one is that the debt crisis that has gripped the US for the past six months has now morphed into a wider economic crisis which may or may not be classed a recession. Fact two is that over the past few weeks the reality of this situation has dawned on the investing public in the US and the rest of the world. To date the Australian equity market has played follow the leader despite the fact that we are operating in an economy that is growing strongly. The US has probably got more falls ahead of it. We have not seen the full purge from losses in the system relating to subprime debt and growth is predicted to slow further. The US economy looks set to feel more pain before it recovers. And Britain and Europe are also feeling some early signs of economic weakness. Australia is in a different position. However, this is not reflected in our stockmarket, which has been falling in line with the US. So the Reserve Bank governor, Glenn Stevens, is now left in a particularly difficult dilemma. The Consumer Price Index numbers released yesterday for the December quarter showed we are facing inflation above the comfort targets set by the bank. And in two weeks the Reserve board will need to decide whether to combat this by increasing interest rates in the midst of an equity meltdown. The experts are divided on which way the board will go. The slim majority take the view that Stevens will ignore the gyrations of the stockmarket and lift rates by 25 basis points next month. The rest think the board will wait until March in order to allow some calm in the markets. But they all agree that rates will rise over the next couple of months. In forming this decision the board will need to make a big judgment on the effects of the weakening economy on the booming Asian markets - in particular China.The contagion effect on China and Asia generally is a big call. If China's domestic demand is strong enough to compensate for falling demand from US consumers then Australia, as a provider of China's raw materials, should also be sheltered. The counter view is that if the non-Asian economies decline this will damage the Asian growth engine and the world will move into a cyclical decline. And this is just what equity markets are telling us. If China can successfully digest a US slowdown then Australia can as well. And if this is the case our broader market should not fall too much further and our big resource stocks like Rio and BHP have already been oversold. Stevens's comments to date suggest he is of the view that Asia/China remain robust and this will be reflecting in monetary policy settings. No one is prepared to back away from expectations of increases in the prices of Australian coal and iron ore of at least 30 per cent this year. This suggests that on fundamentals, the Australian market has fallen as far is it needs to. But it is not all about fundamentals. The reality is that if the US markets' bug continues to worsen the Australian market will suffer as well. The US Federal Reserve's attempts to shoot the money gun at the problem might alleviate the problem - but it won't go away. The Australian market will continue to follow the direction set by the US but the degree of decline should be different. The pitch of the downward trajectory should be more shallow in Australia. Make no mistake. The Australian equities market probably has further to fall before it reaches the bottom, but in a global economy capital should follow growth - and surely Australia should be better positioned than many Western economies.
© 2008 Sydney Morning Herald
