8/4/2019 2011 Aug 18 Olivers Insights the Share Market Panic What Happened to the Global Economic Recovery

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The share market panic what happened to theglobal economic recovery?

Key points The fall i share markets ver rece t weeks re ects

i creasi w rries ab ut US a Eur pea r wth ac cer ver me ts are l er able t resp .

Shares are cheap, but the risk f a US recessi has clearlyi crease a if e is the way shares ca et a l tcheaper. Sh rt-term i vest rs sh ul remai cauti us.H wever, if we are ri ht a the m re likely utc me tur sut t be l w messy r wth but t a retur t recessi ,the curre t valuati s make shares attractive fr m al -term perspective. Theref re avera i i ver timew ul make se se.I have observed that not the man who hopes when othersdespair, but the man who despairs when others hope, isadmired by a large class of persons as a sage. J.S. Mill

IntroductionAfter the eve ts f the last few weeks its easy t be bearish. Afterplu i early 20% fr m their hi hs earlier this year t the l wslast week, l bal share markets have reb u e by ar u 6%.

But markets remai twitchy.The slump i markets ver the last m th aturally raises a l t

f questi s: What is rivi it? Are we seei a re-ru f thel bal a cial crisis? What is the risk f a retur t recessi ?

Ca Chi a save the w rl a ai ? Have shares b tt me ? H wvul erable is Australia?

Why the sharp all in shares (and othergrowth trades)?Put simply, shares have take a tumble fears f a retur trecessi i the US a Eur pe, a w rries this will ra wthe rest f the w rl . A few m ths a we th u ht that l bal

r wth was just i thr u h a temp rary s ft patch ( theback f Japa ese supply chai isrupti s a the earlier sur e i

il prices) a that eve th u h shares mi ht remai v latile asee further weak ess thr u h the September quarter, the trew ul remai up as pr ts c ti ue t rise a l bal m etaryc iti s remai e easy.But the eve ts f the last few weeks have calle this view i tquesti . Ec mic ata has remai e weak a ebt crises i theUS a Eur pe are i creasi the pressure f r m re scal austerityat a time whe r wth is fra ile. P litical bumbli b th si es

f the Atla tic, Sta ar & P rs w ra e f America a fearsf m re w ra es t c me have ly c mp u e these fears.

Furtherm re, mem ries f the 2008-09 l bal a cial crisis arestill fresh i the mi s f i vest rs s the attitu e seems t besh t rst a ask questi s later.

Are we seeing a re-run o the globalfnancial crisis?Its still early ays yet, but ur view is this is very iffere t t the

l bal a cial crisis. Public ebt pr blems have bee brewif r s me time s exp sures sh ul be well k w a m retra spare t. The levera e a c mplex a cial e i eerithat cause s much tr uble i the l bal a cial crisis is t

EdITIon 24 18 AUgUST 2011

Shane Oliver, Head of Investment Strategy& Chief Economist

a fact r w. I terba k le i markets are much bettersupp rte by ce tral ba ks. C seque tly, while i terba kle i sprea s (the iffere ce betwee what ba ks char e tle t each ther a expecte f cial sh rt-term i terest rates i.e. the ver i ht i exe swap [oIS] i the chart bel w) acre it sprea s (the iffere ce betwee c rp rate a ver me tb rr wi rates) are picki up, they remai relatively l w.

Money and credit market spreads are up, but well below globalfnancial crisis highs

S urce: Bl mber , AMP Capital I vest rs

While its early ays yet, the risk f a c mplete seizi up i lemarkets i clu i i areas like tra e a ce that helpe spreathe l bal a cial crisis t emer i c u tries as ccurrei late 2008 seems l w. H wever, the rece t speculative attacks

Fre ch ba ks a m ves by US m ey market fu s t st ple i them US llar fu s are w rth watchi . This is evi e

i the reater rise i Eur pea le i sprea s c mpare t theUS i the chart ab ve.

What is the risk o a return to global recession?The risk f recessi has i crease si i ca tly i Eur pe athe US. Fiscal austerity is ccurri much earlier tha is esirable,a rece t p litical wra li has put public ebt pr blems fr ta ce tre i i vest rs mi s a ealt a hu e bl w t busi esa c sumer c e ce. Eur pe is pr bably the bi est risk. Itseems t be stuck i a ever-w rse i cycle f peri ic i vestpa ic ver ebt bl w- uts, causi m re scal austerity, causiweaker r wth, causi further bu et eteri rati , causim re market pa ic, causi m re austerity a s . Thispr cess starte i the peripheral c u tries but w appears t besprea i i t Italy a Fra ce. A scal u i is a l wayw t s lve curre t pr blems a yway, a the Eur pea Ce tralBa k seems u willi ( r u able) t pr vi e m etary relief.A the US is w starti w the same path with scalausterity set t k ck up t 2% fr m r wth ext year. H weverthere are several reas s t believe that while the risk f recessii the maj r i ustrial c u tries has i crease substa tially, it willpr bably just be av i e : The fall i il a c mm ity prices e erally will take press

ff h useh l bu ets a busi ess c sts. Cyclical sect rs that ca push the US ec my i t recessi

are alrea y at recessi levels e. . h usi . L er-term b rr wi c sts i the US have falle t

extra r i arily l w levels a the US Fe eral Reserve iseffectively c mmitti t keep them there f r tw years.This is e abli h me w ers t re a ce t l wer rates.

near-zer retur s cash are maki it very if cult f r USc mpa ies t c ti ue a i t their alrea y rec r cashst ckpiles. The i ce tive t et ut a i vest, r at least buback shares r ther c mpa ies, is hu e.

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and US OIS, % (LHS)Gap between 3-month euro

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8/4/2019 2011 Aug 18 Olivers Insights the Share Market Panic What Happened to the Global Economic Recovery

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Important note: While every care has bee take i the preparati f this cume t,AMP Capital I vest rs Limite (ABn 59 001 777 591) (AFSL 232497) makes

represe tati r warra ty as t the accuracy r c mplete ess f a y stateme t i iti clu i , with ut limitati , a y f recasts. Past perf rma ce is t a reliable i icat r

f future perf rma ce. This cume t has bee prepare f r the purp se f pr vi ie eral i f rmati , with ut taki acc u t f a y particular i vest rs bjectives,

a cial situati r ee s. A i vest r sh ul , bef re maki a y i vestme tecisi s, c si er the appr priate ess f the i f rmati i this cume t, a

seek pr fessi al a vice, havi re ar t the i vest rs bjectives, a cial situatia ee s. This cume t is s lely f r the use f the party t wh m it is pr vi e .o

I_ 1 8 0 8 1 1

Its l ki i creasi ly likely the US will hea w the pathf a ther r u f qua titative easi (i.e. QE3 which

i v lves pumpi m re cash i t the US ec my). Whilee ca ebate the seemi failure f QE1 a QE2 t spark a

str rec very, the US pr bably w ul have bee a l t weakerwere it t f r these acti s a at least it seems t havepreve te the US fr m sli i i t price e ati .

We put the risk f a retur t recessi i i ustrialise c u triesat 40% sli htly hi her i Eur pe, but sli htly l wer i the US with fra ile sub-par r wth f ar u 1% t 1.5% bei the m stlikely utc me at ar u 60% cha ce.

Can China save the world again?This bri s us t the emer i w rl a Chi a. Pr vi i there is

ryi up i tra e a ce, it is likely Chi a a the emer iw rl will be able t h l up. I ati ary pressures i Chi a athe rest f the emer i w rl are alrea y fa i the back fl wer il a f prices, a with r wth c mi ff the b il thissh ul clear the way f r easier m etary p licies. With sh rt-term i terest rates havi i crease ver the last tw years thereis ple ty f sc pe t cut, u like i a va ce c u tries. Sec ly,public ebt levels i the emer i w rl remai l w s there isstill ple ty f r m f r stimulus if ee be. overall Chi a is likelyt see r wth f ar u 8% t 9% a emer i c u tries ar u5.5% which implies l bal r wth f 3% t 3.5%. This is well bel wI ter ati al M etary Fu expectati s but t isastr us.

Are shares a good buy?After sharp falls i share prices a b yiel s, shares arevalue several metrics. Price t ear i s multiples l bal,Asia a Australia shares have falle t ar u 10 times, wellbel w l -term avera es. A ivi e yiel s have rise sharplyc mpare t b yiel s. This ca be see i the f ll wi chartwhich relates t Australia shares. This mea s shares ly requirem est capital r wth t pr vi e a attractive retur premiumversus b s.

Australian shares the dividend yield is 2% above the bond yield

S urce: gl bal Fi a cial data, AMP Capital I vest rs

H wever, while shares may be cheap, it es t mea they haveb tt me . The ext table f cuses US shares as they set thecyclical irecti f r shares elsewhere. As ca be see , all USrecessi s ver the last 50 years have bee ass ciate with asharp fall i the US share market. Whats m re, the l w i theshare market has always c me after the recessi has be u(by a avera e f i e m ths). Ri ht w, its har t ar ue a USrecessi has c mme ce , but if y u believe e is the waythe US shares are ar uably a l way fr m b tt mi . A thismea s l bal a Australia shares as well.

US recessions are invariably bad or sharesUS recessions* Associated all in US shares (S&P500)

Period PeriodLow versus start o recession, months % Fall

Apr 60-Feb 61 Au 59-oct 60 6 -13.9dec 69-n v 70 May 69-May 70 5 -34.7n v 73-Mar 75 Ja 73-oct 74 11 -48.2Ja 80-Jul 80 Feb 80-Mar 80 2 -17.1Jul 81-n v 82 n v 80-Au 82 13 -27.1Jul 90-Mar 91 Jul 90-oct 90 3 -19.9Mar 01-n v 01 Mar 00-oct 02 19 -49.1

dec 07-Ju 09 oct 07-Mar 09 15 -56.8Avera e 9 -33.4

*As e e by the nati al Bureau f Ec mic Research i the US.S urce: Th ms Fi a cial, AMP Capital I vest rs

H wever, if recessi is av i e i fav ur f just l w messy r wththe the w si e may be less c cer i , say a 12-m thh riz . F r example, with Australia shares pr vi i a r sse up

ivi e yiel f ver 6%, assumi pr ts r w just 4% per a um(pa) a share prices m ve i li e with this the the t tal retura me ium-term view is ar u 10%. This is at a time whe the b yiel is just 4.5%. Furtherm re, ba k ep sit rates are starti t fallas ba ks are awash with cash, wh lesale i terest rates have fallea cre it r wth has sl we t just 3% pa. This mea s the cash

w fr m shares is w back ab ve that fr m ba k i terest.Australian dividend yield is up, deposit rates are going down

S urce: Reserve Ba k f Australia, Bl mber , AMP Capital I vest rs

How vulnerable is Australia to a new globaldownturn?Australia is vul erable t a y re ewe l bal w tur , ive impacts

c e ce, a cial ws, a p te tially tra e. H wever,Australia is far better place t withsta a l bal w tur a wesee the risk f recessi here as l w at ar u 20%. I terest rates havea l way t fall. The Australia llar w ul likely fall if the l balec my retur s t recessi b sti c mpetitive ess. Public ebtis a fracti f that i ther c u tries a s m re stimulus ca beapplie if ee be. C rp rate eari levels are l w a c mpa ies arecashe up. Ba ks are less epe e t l bal markets f r fu itha i 2007. Australia h useh l s have als built up a lar e savi sbuffer. Fi ally, ur key exp rt markets i Asia are m re secure thath se i Eur pe a the US.

Concluding commentsF r sh rt-term i vest rs, there is a case t remai cauti us. F rl -term i vest rs, attractive share market yiel s, l w a falli yiel s b s a ba k ep sits a the likelih f m rem etary stimulus the way su ests shares may be attractivea l er-term basis, mea i there is a case t avera e i ver time.Dr Shane OliverHead o Investment Strategy and Chie EconomistAMP Capital Investors

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