Global Sharemarkets - Recent Changes

Written on the 12th of May 2010

I would like to provide you with an update on some recent developments in global sharemarkets. There has been increased sharemarket volatility over the last few weeks but it is also important to be aware that the Australian sharemarket, as measured by the S&P/ASX 200 index, reached an intra-day high point on 15 April 2010 relative to its low point in March 2009. Following the recent market high point, the Australian sharemarket has retraced some of these gains and this has been driven by global and domestic events, primarily by issues in Europe as well as proposed Australian regulatory changes.

However, it is very important at times like this to remain focussed on the long term and to understand that volatility is a natural characteristic of the sharemarket. History shows us two key learnings - the sharemarket does recover after experiencing declines and it is important to “ride out” the volatility. These learnings have continued to apply over the more recent past. As an example, from the March 2009 lows, the Australian sharemarket (as measured by the S&P/ASX200 Index) has rebounded around 45% as at the market close on 6 May 2010. Clearly this is a significant rise in a very short period*.

Times like this also remind us of the importance of having a diversified portfolio with exposure to all the main asset classes. Diversification and a focus on the long term will continue to remain vital ingredients in the achievement of long term wealth creation.

An update on recent economic and market developments
Below are some key events that have occurred over the last few weeks. While there were some indications that markets have started to stabilise, global economic issues especially around the Greek debt problems have continued to emerge.

Over the last few weeks the main concern for investors has been the possible European debt contagion which has continued to drive markets down. While the Greek Government passed a set of severe spending cuts amid further violent protests, fears of the stability of the banking systems in several European nations including Italy, Spain, Ireland, Portugal and Britain continue to concern investors as the banking system could be impacted by further sovereign debt woes sparking what could be a new “credit crunch”.

At the European Central Bank (ECB) Meeting (6 May 2010), the ECB kept its main re-financing rate on hold at 1%.

As at the close of markets on 6 May 2010, some key European markets have declined in the last few weeks in the vicinity of 10% (the UK sharemarket) to 13% (France).

On 6 May 2010 the US Dow Jones index at one stage fell nearly 1,000 points, but recovered to close down 347.8 points (down 3.2%) for the day. The large fall was partly blamed on a technical glitch or mistake trade on the stock Proctor & Gamble which caused the stock to fall 37%.

However, daily sharemarket fluctuations in the range of -3% to +3% have been a common occurrence over the past 2-3 years relative to the longer term and such volatility is likely to continue in the future.

A very important point to be aware of is that despite recent volatility, sharemarkets around the world have rebounded strongly from the previous lows set in March 2009. Using the US Dow Jones index as an example, this sharemarket index is still up 0.9% for the calendar year to date (as at 6 May 2010) and up just over 60% from the March 2009 lows*.

Despite further headwinds facing the global economy, fundamental corporate earnings growth appears to remain intact for calendar year 2010 and 2011. US corporate earnings for the first quarter of 2010 look pleasing and Australian second half 2010 forecasts are still improving with overall global equity markets remaining at attractive valuations.

In terms of the Australian dollar it remains extremely volatile, trading in a broad range between 0.87 and 0.93 USD.

Market outlook

In summary, despite the current short term correction in global sharemarkets, overall equity market valuations continue to look reasonably valued on current earning estimates. This is despite global structural risk issues related to the aftermath of the global financial crisis, specifically high Government debt and global unemployment, in addition to currency readjustments. These are issues that are anticipated to be a consistent theme for an extended period.

Global economic data has continued to improve over recent months with US calendar year 2010 quarterly reporting numbers continuing to pick up since the earnings lows of the fourth quarter of 2008. The weak US dollar combined with substantially improved productivity increases has provided the basis for a strong earnings lift for a significant component of companies within the US S&P500 index.

A key for US growth is the unemployment data which has continued to improve in recent months. Helping stimulate the US economy, the US Federal Reserve (Fed) continues to keep the accommodative monetary policy in place, and this is likely to continue for most of the rest of the year.

Corporate Australia’s balance sheets remain strong with gearing levels for the ASX200 at the lowest levels for many years at around 27% for the Industrials component of the market.

However, risks remain for the Australian sharemarket, notably a rising interest rate environment (official cash rates are now at 4.5% and possibly rising), an inflation rate of 2.9% (close to the Reserve Bank of Australia’s (RBA) upper end range) and increasing regulatory risks, for example the proposed “Super Profit Resources Tax” on resource companies. The impact of proposed regulatory changes has been a detractor from the Australian sharemarket causing share prices to fall on “blue chip” stocks such as BHP and RIO Tinto.

While the outlook for the Australian sharemarket and markets globally may remain challenging in the short term, it is important to remember that the Australian sharemarket has generated returns for investors over the 15 years ending March 2010 of 10.8% p.a. This is as measured by the S&P/ASX 300 Accumulation index which includes both share price movements (capital growth) as well as dividends (income)*.

Expected returns over the next five years for the Australian sharemarket are around 8-9% p.a. However, this does not mean that each year investors will receive 8-9% as there will be volatility and negative returns from time to time over this period. The 8-9% p.a. forecast is the expected average annualised return**.

While the short term outlook for Australian and global sharemarkets may be uncertain and volatile, they have historically been solid investments, delivering strong long term returns. It is important for investors to focus on the long term and “ride out” any market volatility and look to possibility take advantage of oversold markets affected by short term “noise”.

Remain focused on the long term

We understand investors’ concerns in times of heightened market volatility. Whilst the risks and volatility inherent in investing may seem to prevail at times, losing track of long term objectives by focusing on the short term poses a far greater risk to achieving longer term goals than any past or present economic event.

While times like these may cause investors to question their investment strategies and consider increasing investments in cash and short term money-market products, this course of action may result in being worse off in the long run than staying with a well diversified plan and riding out the volatility. History has demonstrated that a large proportion of investors invest near market peaks and sell near market lows. While investing at market peaks is not the most favourable entry point, as markets grow over the long term, timing becomes less relevant.

It is important you notify me of any material changes to your situation, needs or objectives so I can ensure my advice continues to remain appropriate.

Please contact me if you would like to arrange an appointment to discuss your situation or if you require any further information.

ThreeSixty, in the compilation of this letter has sourced factual and statistical data from the following providers:

Mercer, Morningstar, NAB Wholesale Banking, IRESS, Ord Minnett, JBWere and Thomson Reuters .

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please contact me prior to acting on this information.

* Past performance is not a reliable indicator of future performance.

** This information is based on information considered to be reliable. Opinions constitute our judgement at the time of issue and are subject to change. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document. Except for liability which cannot be excluded, all of National Australia Bank Limited, related subsidiaries, its directors, employees, agents and related bodies corporate disclaim all liability in respect of any error or inaccuracy in, or omission from, this document and any person’s reliance on it.