There's no doubt negative sentiment is driving shares right now. For that reason, Colin Whitehead from Fat Prophets expects this period of volatility to persist for longer than it should. Michael McCarthy from Citi Index agrees saying that traders are describing the recent phenomena of five per cent swings in indices and three cent ranges in the Australian dollar, as the “new normal”.
But the question must be asked, did our market rally in the second half of last year too fast, too soon? Brokers and analysts constantly told me at the time, that shares were trading on 2011 earnings. What happened to 2010? Were traders being overly optimistic? The simplistic view is that where shares were at towards the end of last year, is likely to be where shares will be at the end of this year.
My point is, a correction of sorts was expected. The severity of that correction however, has come as a bit of a surprise. Colin Whitehead points out, the Dow Jones Index has retraced from more than 11,000 points to just 10,000, while locally, the S&P/ASX200 has shed more than 700 points since its recent high. That's a near 15 per cent decline in just about 5 weeks.
The effects of the European debt crisis have become a bigger issue than first thought, even though measures to deal with this issue will eventually be resolved. Markets aren't happy at the lack of coercion and agreement amongst EU member nations and the lack of a swift response.
And now there's also the potential for conflict on the Korean Peninsula. Any conflict may impact on trade and that's not good for global markets. Still, it's more the uncertainty surrounding these factors that are spooking investors, rather than the events themselves.
Locally, the Resource Rent Tax seems to be impacting the market. Credit Suisse claims the tax may see the closure of OneSteel's Whyalla plant in South Australia because it would make the operations there unprofitable and cash consuming. While the tax will impact companies in different ways, one must ask if mining stocks, generally, have been oversold as a result. Interestingly, JP Morgan says Rio Tinto for example has been “excessively oversold” because of the proposed tax along with a potential China slowdown and European economic concerns. For Rio anyway, the broker notes that even if the tax is passed, the company has significant large scale, long time investment opportunities outside of Australia. Once again, the key here….uncertainty.
Experts say the fundamentals of our companies are good, and investors will eventually focus on those fundamentals instead of all the 'noise' around at the moment. Ben Potter from IG Markets says Monday's and Wednesday's rebound in shares, particularly the buys of beaten-up blue chip names was encouraging, and reflects renewed confidence that had not been seen in recent weeks, marking a small but important change in underlying sentiment. But he notes, in this volatile market, it's up one day, and down the next, with these conditions having investors and traders second guessing themselves.
At least there's clear signs our economy will still grow. The annualised growth rate of the Westpac-Melbourne Institute Leading Index came in at 8.7% in March, well above its long term trend of 3%. The index shows the likely pace of economic activity three to nine months into the future. Bill Evans of Westpac is expecting the economy to grow at 3.6% for 2010/11, that's above Treasury's budget forecast of 3.25%.
As for interest rates, Bill Evans says there is little chance of a change in rates with the global tensions in financial markets signalling that a pause which the RBA indicated following the last rate hike in May, is almost certain to occur.
