Why is the Australian sharemarket spooked? A SmartCompany Q&A

Just when we thought the economic recovery was set to push Australia towards another boom period, an outbreak of jitters has hit that most immediate of economic measures – the sharemarket.

Australian shares fell 6.8% last week, and have now fallen 10.4% since hitting a recent peak on April 15. It’s a similar story around the world – over the same period the UK FTSE has lost 12.1%, the German Dax is down 9.2% and the Japanese Nikkei has lost 8.1%. The Dow Jones has lost 7.4% since peaking on April 26.

It’s a worrying sign, but is it a result of a bit of short-term panic or a signal of deeper problems? Time for a SmartCompany Q&A.

I thought the global economy was supposed to be recovering. And I thought Australia was the strongest economy in the known universe. So what’s going on here?

The Australian sharemarket is dominated by two sectors – banking and resources – and in the last week we’ve seen both hammered for not unconnected reasons.

The banks are suffering from the debt crisis currently plaguing Greece and now spreading throughout Europe. The theory is that if Greece or another nation was to default, banks in Europe would be slammed and would have their lending capacity crippled. Given Australia’s banks rely to some extent on foreign credit markets, the pain felt by the European banks would lead to higher funding costs for Australia’s institutions. Not only would our banks hurt, but we’d all hurt when the higher rates are passed through.

Mining stocks are feeling a bit of this referred pain (any European collapse would likely put the brakes on global economic growth and therefore demand for commodities) but they have also been punished after the release of the Government’s resources super profits tax.

Anything else weighing on the minds of investors?

Plenty. This morning CommSec economist Craig James has produced a little list of all the things that have gone wrong over the last month and given investors something to worry about. These include:

  • Rating downgrades for Portugal.
  • The volcanic ash cloud across Europe.
  • A major oil spill in the Gulf of Mexico.
  • Criminal proceedings against Goldman Sachs.
  • Potential (and subsequent realisation) of a hung Parliament in the UK.
  • Fears of a property crash in China.

James argues that many of these problems may not be as bad as they appear, and markets seem to be running on fear at the moment rather than rationally considering the problems and examining potential solutions.

But of course, that’s exactly what happens when the mob moves the wrong way. “In more jittery markets, investors shoot first and ask questions later,” James says.

No wonder I always seem to get caught in the crossfire. So are any of these issues being resolved?

Not in the short-term. Let’s just look at James’ little list.

  • The debt crisis in Europe seems to be spreading throughout Portugal, Spain and Ireland into places like Italy and even the UK.
  • The worst of the volcanic ash problems seems to be passed, although ash closed airports in Spain, Portugal and Italy at the weekend.
  • The attempt to stop the oil spill in the Gulf of Mexico at the weekend failed.
  • Goldman Sachs remains under fire, with rumours of further probes still floating around.
  • The post-election battle for power in the UK continues.
  • Fears of a slowdown in China show no signs of going away any time soon.

Great. What about the big two issues, the Greek problem and the resources tax? I thought Greece had got its bailout.

The Greek situation is developing by the hour. Greece did receive a bailout package from the European Union about a week ago, but almost immediately commentators began suggesting it wasn’t big enough. So over the weekend, European leaders got together again to try and come up with a package of measures to stop the Greece situation from infecting the wider EU.

This morning, reports suggest the European Union has agreed to emergency measures worth €500 billion ($A717 billion) to prevent Greece’s debt crisis causing turmoil in other euro zone countries. The package, a mix of loans and loan guarantees, should hopefully start to provide a bit of reassurance to markets. The big test of this will come overnight when US and European markets deliver their verdict on the rescue package.

What about the resources sector problems?

It appears negotiations have kicked off between the Government and the mining sector, who have spent most of the past seven days yelling at each other. This seems to be an issue that can be resolved – the miners don’t like the tax, but they will probably accept it if the Government reduces its tax grab, either but cutting the top-line rate down from 40% or adjusting the way the “super profits” are calculated.

Okay, so these two issues are not far from being resolved?

Hopefully not. Certainly the Australian market has taken heart from the Greek bailout and has jumped 1% at the open, which is a good result considering Wall Street fell on Friday night.

So the panic might be at an end?

Certainly that is what Craig James is arguing today. When markets are running on fear they can be hard to stop, but as the situation in Europe clears up, James says the irrational selling that we’ve seen should start to subside.

However, there are a few caveats.

There always is.

Well, markets are not easy beasts to predict.

The situation in Greece does remain fluid, and for the bailout to work the citizens of Greece will have to accept a bit of bad medicine in the form of tax hikes and lower government spending.

There will also doubtlessly be questions as the days and weeks go on about whether the rescue package is big enough and timely enough. This drama feels like it has some way to run yet.

The resources tax issue also has a long way to go – and a long time before the tax actually come in effect in 2013. While last week’s sell-off might look a little panicked as time goes on, this is an issue that will weigh on investors’ minds for some time.

And finally, I would add that we might see further pressure on the shares of any company exposed to consumer spending. The analysis and anecdotes I’ve heard coming out of the retail sector in particular suggests that customers are basically on strike right now, and rising rates won’t do anything to help.

In summary, beware of a volatile little period ahead.

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