Frequently asked questions - market volatility
- What has caused the market downturn?
- Why is this affecting Australia?
- What does all this mean for Australian investors?
- Can we expect market volatility to continue throughout 2009?
- What is being done by governments around the world to fix the crisis?
1. What has caused the market downturn?
While the sub-prime / credit crunch crisis really hit a year ago, the roots of the problem can be found in years of poor mortgage lending, especially in the US. Unfortunately, vast amounts of these bad loans were packaged and on-sold to financial institutions around the world.
Falling mortgage-backed asset prices led to the eventual “credit crunch” with financial institutions unwilling to lend to each other. As a result of the credit crunch, the lack of the availability of credit is causing economic growth around the world to slow quite sharply. Perhaps more importantly, the global banking system faces its own crisis of confidence and as a result, governments have been forced to step in, guaranteeing deposits, flooding the money markets with cash and buying up assets to relieve the pressure in the financial markets.
2. Why is this affecting Australia?
Economists talk about the term 'Contagion', and yes, it comes from contagious. 'Contagion' is the idea that a financial crisis in one country is very likely to cause a crisis in another. Companies in a stable economy would or could be denied financing simply because another economy in the region is failing.
Lenders worldwide became unwilling to lend and interest rates rose sharply. Increased borrowing costs meant some companies had difficulty refinancing debt. Money (credit) is now more expensive and not so easy to obtain for investors like us, for large companies and big banks both globally and locally.
This has now caused what's called a global 'credit crunch'.
3. What does all this mean for Australian investors?
Most peoples’ investments have been negatively affected by the downturn in the markets – it may be cold comfort – but you're not alone. The Australian sharemarket has dropped 38.4% over the twelve months to 31 December 2008 – one of the worst years on record.
However there are positive local factors you should consider when reviewing your investments:
- We have low unemployment (4.4%¹), a big government surplus and inflation is under control. Crucially, the banking sector is very strong thanks to the level of regulation and oversight in existence.
- The Australian financial regulatory system is now being heralded as the optimal model for developed nations as outlined in the recent G30 report.
- All our major banks are highly profitable and of the 20AA rated banks in the world, four are in Australia.
- While the Chinese and Indian economies will not survive the credit crunch unscathed, urbanisation in those two giant countries should continue at speeds sufficient to underpin demand for our resources.
¹Source:Investment Solutions, 30 November 2008
4. Can we expect market volatility to continue throughout 2009?
Nobody knows exactly how long this downturn will last. However, central banks and other regulators around the world are doing all they can to fix the crisis. As with many government actions in the economy, these will take time to take effect. However if they do restore confidence in the banking system - and they should - we may see a sharp turnaround in sentiment.
5. What is being done by governments around the world to help fix the crisis?
By historical standards this is a very severe global economic crisis. Central banks and other regulators around the world are doing all they can to fix the crisis.
Australia
The Australian government announced a $10.4 billion stimulus package, including $8.7 billion worth of direct payments to pensioners and families, which was paid in full in December 2008.
The US
The US government has launched a Troubled Asset Relief Program (TARP) worth US$700billion. It is estimated they have injected another US$900billion in cash into money markets to ease the credit crisis.
Europe & UK
Governments in Europe have also had to bail out large financial companies - such as Northern Rock in the UK and Fortis in Belgium.
China
China's central bank has cut rates for the first time in six years.