A tough start to 2008

18 January 2008: So far this year, the Australian share market is down by about 11%. Contributing to this fall was the news on Wednesday that Citigroup, one of the world’s largest financial institutions, had announced a larger than expected US$9.8 billion fourth quarter loss as a result of write-downs linked to the US sub-prime mortgage market. This led to a major sell-off on Wall Street which was subsequently felt around the world, including here in Australia where the local market lost more than $30 billion of value in one day.

A continuation of recent market volatility

What we’ve seen so far in 2008, in our view, is arguably a continuation of the market volatility that we’ve seen in global investment markets over the last year or so. The problems in the US sub-prime mortgage market are well known, but we think the fallout from these problems has yet to be fully realised. This has created a great deal of uncertainty amongst investors already concerned with the threat of a possible US recession, so it’s perhaps not surprising that the market reacted the way it did this week to Citigroup’s announcement.

Unfortunately, no one can say with any real confidence just how deep the problems in the US sub-prime mortgage market really are, so it’s possible we may yet see more losses from other major banks in the near-term which could result in further sell-offs in global share markets.

Another factor that’s been weighing heavily on global share markets in recent months is the threat of a recession in the US. The housing market in the US remains very weak and this has only been exacerbated recently by a string of softer economic data and the ongoing problems in the sub-prime mortgage market. Some economists have put the chance of a recession in the US at 50%, but we think this is probably a little overdone. We actually believe the chances of a serious recession is less likely than the consensus view would suggest, however, if it were to happen, we would expect it to be short-lived, with most of the companies we invest in from Australia bouncing back pretty quickly.

What does all this mean for Australian investors?

The upshot of all of this is that market volatility is becoming more and more common, so bigger market swings are something that we believe investors will have to get used to. Just a few months ago, the Australian share market underwent a similar correction, though that proved to be short-lived after the US Federal Reserve came to the party and eased interest rates. That had a positive effect on global share markets and we think the same will happen this time around.

However, we do believe it’s inevitable that rising market volatility will have an impact on future investment returns. The Australian share market has posted strong double-digit returns each year for the last four years, but it’s unlikely that we’ll see similar returns again in 2008. That said, we don’t believe we’ve come to the end of the ‘bull’ market that began back in early 2003, so we do still expect returns to be positive.

In terms of interest rates, we think the Reserve Bank of Australia (RBA) has some room now to wait. A month ago, we would have expected another rate rise in either February or March, but given what’s unfolded recently, we think the chance of a rate hike has faded somewhat. We’ve already see evidence that China – the main driver of our economy – is beginning to slow, and that will take some of the pressure off the RBA to lift interest rates further. And that’s perhaps the good side to this story – that Australia has got a different economic cycle to the US, meaning we no longer have to dance to their tune. We now have a more independent economy, more linked to a variety of markets, particularly Asia. So while a slowdown in the US won’t be enough to force Australia into recession, it will take some of the heat out of our economy and potentially leave interest rates more stable.

BT’s strategy to combat market volatility

In this volatile environment, we will continue with our strategy of focusing on companies that have secure cash flows, limited expectations in their valuations and sound management teams. We believe there are enough pockets of good value in the Australian market to remain invested and we actually think the best stocks in the market at the moment are probably those that have fallen off the radar; mainly good quality companies that aren’t held hostage to what’s been happening in the US and the rest of the world.

As an investor, we believe it’s important to remain focused on your long-term investment horizon, and not get too caught up in short-term market movements. There have been plenty of major market events over the last twenty years that have hurt share markets, but they inevitably bounce back with time. It’s also important that you consider the benefits of seeking professional advice around your own investment needs, and protect your investments at all times with a well-diversified portfolio.

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Disclaimer

The information in this update is current at 18 January 2008. It has been prepared without taking account of your objectives, financial situation or needs. The information in this update is factual only. It does not constitute financial product advice, nor should it be considered a comprehensive statement on any matter nor relied upon as such. Before acting on this information you should seek independent financial and taxation advice to determine its appropriateness to your objectives, financial situation and needs. It may contain material provided directly by third parties, but while such material is published with necessary permission, BT Financial Group (BTFG) accepts no responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, BTFG intends by this notice to exclude liability for this material. The information in this update is given in good faith and has been derived from sources believed to be accurate at its issue date. No company in the Westpac Group nor any of their related entities, employees or directors gives any warranty of reliability or accuracy or accepts any responsibility arising in any other way including by reason of negligence for errors or omissions. This disclaimer is subject to any contrary requirement of the law.