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Markets
Is the party over for the US?
Trevor Hoey, September 3, 2007
In July/August the S&P/ASX All Ordinaries index fell by nearly 800 points in response to severe volatility in US markets. The Dow Jones index fell from more than 14000 points in mid-July to less than 13000 points in mid-August, representing a decline of about 8 per cent. By comparison the S&P/ASX All Ordinaries fell by about 12 per cent.
The underlying reason for the instability was the growing concern surrounding the sub-prime lending industry in the United States. Australia’s financial institutions accounted for a significant part of the fall in local markets despite the fact that only 7 per cent of outstanding mortgage debts fall into the sub-prime category, as opposed to 27 per cent in the United States.
The US has a cold
Perhaps the recent knee jerk reaction stems back to the old adage, ‘When America catches a cold the whole world sneezes.’ But whether the US should be the barometer for global markets is questionable. Globalisation and the emergence of developing nations as important economic centres has helped to create an environment where growth is being driven by a broad range of social and economic factors.
It could be argued that while the state of the US economy is important, it should be considered a spoke in the wheel of a global universe rather than the drive shaft that determines the speed and direction of international markets.
But is it contagious
So why should the Australian sharemarket fall in line with US markets, and moreover suffer such an exaggerated reaction? Given that the sub-prime mortgage problem related to the US economy, with only a small number of Australian financial institutions having indirect exposure to the crisis, it seems logical that any negative impact on the Australian market should have been minimal.
While there is plenty of historical evidence to support the premise that the Australian sharemarket should move in tandem with the US market, recent trends suggest that there is a growing disconnect between the Australian and US economies – and sharemarkets.
The fact that investment in Australian companies accelerated in recent years despite the fact that US economic and sharemarket conditions were under pressure tends to dispel the long held belief that global markets should move in unison with the US.
A comparison of the sharemarket performances in both countries over the last ten years clearly shows a stark contrast between the pre-2000 mirroring trend and the antithetical shift that has dominated the new millennium.
S&P/ASX All Ordinaries vs Dow Jones (Source: BigCharts.com)
A parting of ways
In the first five years from 1997 to 2002 movements in the Australian market, as they have done for decades, mirrored the US market. While the Dow Jones index fluctuated between about 7000 and 11,000 points, the S&P/ASX All Ordinaries index moved between 2500 and 3500 points – a similar range in percentage terms. The tech boom and subsequent tech wreck were the main catalysts during this period.
Between 2003 and 2006, the Dow Jones index struggled to reach the 11,000 points barrier, and it wasn’t until 2006-07 that the index managed to break through the 12000 point mark that it reached at the height of the tech boom.
Despite a subdued performance by the US sharemarket, the S&P/ASX All Ordinaries index more than doubled from less than 3000 points in 2003 to a recent high of nearly 6500 points, outperforming the US market by about 70 basis points. In fact, in 2004, when the Dow was still wallowing 2000 point below its all time high in 2000, the S&P/ASX All Ordinaries cruised past its previous peak of about 3500 points.
Fight or Flight
If the new millennium represents the line in the sand where the Australian sharemarket moves in a more autonomous fashion, this certainly questions whether there should have been such a severe knock on effect from the US market’s recent demise, and moreover suggests that the current environment may represent a good buying opportunity.
A significant recovery in the Australian market in mid-August suggests that the reaction was unjustified, but this rebound has coincided with a government induced stabilisation in US markets. The sub-prime mortgage issue is far from finished, and Australian investors should focus on the future, in particular the need to establish a strategy that will assist in managing further volatility.
It would seem prudent to steer clear of companies that have significant US exposure, particularly in the financial, housing and discretionary spending sectors. But those whose survival instincts are not solely driven by the need to take flight there is the question of redirecting funds.
In a fortnight we will consider companies that are exposed to robust industries within healthy growth economies (including Australia) that are relatively unaffected by trends in the US. In particular, we will profile companies that have clear earnings visibility and preferably a substantial proportion of recurring revenue.
More articles from this week's newsletter:
Markets: Is the party over for the US?
Forums: The mysterious world of stock forums
Superannuation: Stay with super or convert to a pension?
Ask the expert: How to determine the best stock to trade
Politics: Forget the mud, it's about interest rates
Stock of the week: Mermaid Marine buoyant
Smart Investing: Risks of beating the market
Analyst report: Is sub-prime draining our resources?
Commodities: Gold hasn't lost its glitter
Whatever your views, you can discuss this article - or any of Trevor's articles - on our message board Your 2 Cents.
Trevor Hoey is one of Australia's leading finance journalists, having written for Shares, Personal Investor and BRW magazines. Trevor's broad contact base enables him to find out - and report on - the real story behind what's happening at Australian listed companies. Trevor writes for the Australian Financial Review and AFR Smart Investor magazine.
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