Finance

Market rebound on US Fed action… India FTA boon… Credit crunch hits sales deals… US debt crisis risk… Gottliebsen’s correction lessons… Low-doc worries… Home buyers defy global trend

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Market rebound on US Fed action

The S&P/ASX 200 has had its single biggest increase since March 2003 this morning, lifting 3.4% on Friday’s close to 5863.9 by midday today.

The big rise represents a tick of approval by Australian markets for a confidence-creating interest rate cut by the US Federal Reserve on Friday, when it cut the interest rate it charges on loans to commercial banks by 0.5% in an effort to ease the credit squeeze being faced by global financial institutions.

After the benchmark US Dow Jones Index responded positively to the move with a 233 point rise on Friday, it was always likely Australian markets would follow suit.

While market watchers predict there is still likely to be more market volatility to come, a further confidence boost could be on the horizon in the form of a cut to the main cash interest rate in the US. Futures traders are now pricing in a 60% chance the US Fed will cut its cash rate from 5.25% to 4.75% when it next meets.

The Australian dollar also rallied on the US interest rate announcement, lifting to US79.83c after crashing below the US77c mark earlier on Friday.

Mike Preston

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India FTA could help Aussie SMEs

The prospect of a free trade agreement between Australia and India has been welcomed by SME operators with experience of the fast-growing, cricket-loving South Asian nation.

Federal Cabinet has decided to pursue an FTA with India, The Australian reports today. The move follows the Government’s announcement last week that it has approved uranium exports to India.

Sydney-based SME Rye Pharmaceuticals manufactures some of its products under licence in India, and managing director John Price says he can see many more opportunities for his business if a well-negotiated free trade agreement goes through.

“Some of our burn dressing products that involve a little more technology and IP are the ones that are slugged with some fairly substantial import tariffs,” Price says. “There are products we would be keen to export from Australia to India – at the moment tariffs are a barrier.”

Anything that cut red-tape associated with doing business in India would also be welcome, Price says.

“Getting a visa to India is a bureaucratic process – it’s not that you don’t get one in the end, but they love their bureaucracy there and they make sure you’ve dotting your i’s and crossing your t’s,” he says.

Melbourne manufacturer Celtec Engineering exports railway components to India, and product manager Joe Nilsson says import duties make it harder to compete. “They haven’t stopped us doing business there, but they do have an impact, so any reduction in duties would help,” he says.

There could even be opportunities for the Australian IT sector, despite the fact that the IT industry in India is already quite developed and already competes against Australian businesses in some areas.

Australian Information Industry Association chief executive Sheryle Moon says a more open Indian economy will help Australian business ease the chronic skills shortage it currently faces.

“There could be great opportunities in the education space – India’s system is still largely regulated so it’s been difficult for Australian industries to break in there, especially in ICT skills area. If an agreement meant Australian universities were involved in training potential IT workers, that would create a connection with Australia and mean they’ve got degrees that are readily acceptable here,” Moon says.

Moon accepts that an agreement might mean more competition from the huge Indian IT sector, but, she says, that competition is already here and will continue, FTA or not.

“Indian companies are here now, so potentially an agreement could see more upside for Australia given if it opens up trade opportunities on the Indian side,” Moon says.

Mike Preston

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Credit crunch could affect business sale prices

As the cost of credit rises, private equity deals heavily backed by debt are starting to look less attractive. As a result, the prices for businesses that have been inflated by interest from private equity could fall.

Katherine Woodthorpe, executive director of industry group Australian Private Equity & Venture Capital Association (AVCAL), says: “I think that it’s not unreasonable to assume that private equity will be pricing their deals more cautiously if the money they are borrowing is going to cost them more.”

She is not hearing about more cautionary approaches from the industry yet. But last week the Reserve Bank warned about a rising cost of credit.

Australian private equity and venture capital firms raised more than $4 billion and invested just under $2.3 billion in the 2005/06 financial year, according to a Thomson Financial/AVCAL survey. Last year’s figures will be published in September.

See our story You want a money miracle for tips on raising money from private equity firms. And here’s a list of firms that provide venture capital and early stage investment.

But all eyes in the private equity industry are on Canberra today. This afternoon the inquiry into private equity investment and its effects on capital markets and the Australian economy to the Standing Committee on Economics report will be tabled in parliament.

Woodthorpe says based on the evidence, she is hopeful the inquiry will not recommend any further regulation of the sector.

Jacqui Walker

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US debt crisis risk grows

As the easy credit in the US dries up, consumers who are used to drawing down equity on their house to finance more debt are changing tack. They are switching back to credit cards, where debt is at record levels.

It is a worrying trend, and if replicated in Australia could be more concerning because of our reporting requirements, says Christine Christian, chief executive of Dun & Bradstreet.

Christian points out that banks are only required to report to credit bureaus when a customer defaults. However they are not required to report when a new credit card account is opened or the limit offered increased. “This means that the banks don’t know if a business person for example might have one credit card or six, and whether they are maxed out or in a good position.”

She says that only three countries – Australia, New Zealand and France – use the negative credit reporting system. “Others, like the US, use a positive credit reporting system, which gives the banks a much better understanding of a customer’s indebtedness.”

Christian points out that in the past three to four years, the banks aggressive strategy of lending money to businesses vying for a customer base means they have been more focused on market share than on risk. “We are going to see a spill over, and all it will take is for each bank to have one major casualty and they will tighten their credit policies.”

She says the Australian Law Reform Commission is looking at existing systems to put in place recommendations for reform, and a discussion paper is due out next month. “Given the current environment, changes could force individuals to be more financially responsible.”

Amanda Gome

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Gottliebsen’s Seven Lessons from the correction

I saw my first sharemarket crash in November 1960, when I was taking the quotes by hand on the floor of the Melbourne Stock Exchange, then operating on the call system. Since then I have seen several crashes where the market fell by at least 15%–20%, including 1969 and 1987.

I have seen countless corrections and at the moment, our current fall is still in the correction class. Here are some of the lessons from the crashes I have seen.

Lesson 1: If you can hold good assets – shares or property – through a crash you eventually come out on top, although sometimes it takes a while.

Lesson 2: All sharemarket crashes, as distinct from major corrections, are caused by a serious disruption in the credit system, with those who have borrowed to buy shares and other securities being forced to sell.

In 2007 we face a double-whammy – forced sales of shares because of margin lending; and forced sales of commodities (oil and metals) by highly leveraged hedge funds, which is also slashing the Australian dollar.

In turn, that is panicking lenders to Australia, which will put an upward pressure on rates. If there is a sustained market recovery and we avoid a crash, it will be because the central banks of the world, who are aware of the dangers, are able to minimise the effect of the credit system disruption that is taking place.

There are good signs in 2007 but there are large problems.

Lesson 3: It is very hard to pick the bottom of the market, so begin to buy when you see top value. A correction usually develops into a crash when there is a day of “no hope” when people sell stock at any price. We have not yet seen such a day.

Once that no-hope session occurs, it will form a base for recovery, so don’t sell good stocks if there seems “no hope” unless you are forced out. However, recovery can take a while because of the economic repercussions.

Lesson 4: All sharemarket crashes, as distinct from major corrections, are followed by a serious downturn in the economy as the effects of the credit disruption and the discounting of asset prices spread.

Remember, sometimes the property market actually rises after a sharemarket crash (as it did in 1987) but that only puts off the day of reckoning.

Lesson 5: The current fall in share prices is dangerous because it is caused by one of the biggest asset losses the world has seen: the loss of perhaps 10%–15% of US mortgages. And because the worthless mortgages have been mixed with good securities and risk is being repriced, the losses are spreading way beyond the direct investments.

Lesson 6: The Australian housing boom was partly funded by banks and other lending institutions borrowing overseas. Many of our overseas lenders have been hit hard in other markets and have been savaged by the fall in the Australian dollar.

From now on we will have to pay more for our money. On the other hand, investment yields will rise. It will be a great time for yield investors.

Lesson 7: After any major correction – and certainly a crash – there is always a big change in investment managers. This can savage small-cap stocks because the new person simply sells out of any stock they do not understand. Small-cap investors’ fortunes are made by buying good stocks that are thrown out at silly prices when there are no buyers.

Robert Gottliebsen, Eureka Report

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Call for more low-doc regulation

State and federal governments agree more regulation is required to ensure Australia’s low-doc loan market doesn’t go the way of the US sub-prime market, but each blames the other for delays in doing so.

Treasurer Peter Costello yesterday said he was frustrated at the slow pace of change in state laws, according to The Australian Financial Review.

“If the states want to refer powers to us, then we would be willing to step in and take over their powers to legislate in this area,” Costello said.

But the federal Office of Best Practice Regulation, for which Costello is responsible, has sent back a NSW proposal to increase regulation of low-doc loans, citing a need for more details.

“If the treasurer is serious about the proposal, as opposed to grandstanding for the federal election, we’re happy to work with him on any necessary crackdown to protect consumers,” Queensland Premier Peter Beattie told the newspaper.

Mike Preston

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Home buyers defy international credit wobbles

Home buyers shrugged off international credit wobbles to push auction clearances up in the big Sydney and Melbourne auction markets over the weekend.

Melbourne auction clearances were at 79.5%, up on last weekend’s 78.2% and well above the 48.8% achieved this time last year. Sydney also improved 1.3% on last weekend to a 69% clearance rate, according to The Australian Financial Review.

Clearance rates declined slightly in Brisbane and Adelaide, both markets where auctions are a less common way to sell houses.

Mike Preston

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