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Not the day to sell

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Monday night’s events on global financial markets have materially increased shorter-term investment risks and uncertainties. However, as share market values have been pushed further below values that can be justified by longer-term fundamentals, investors are encouraged not to sell out of equity markets at today’s prices and maintain positions for a longer-term recovery.

In summary, the following took place on Monday in the United States (US) and Europe:

  • The US House of Representatives unexpectedly failed to pass a $US 700 billion financial sector rescue package.
  • Instability in the global banking industry has spread, with European based institutions, Fortis, Dexia and Iceland’s Glitnir bank all reportedly facing difficulties and requiring various forms of assistance.
  • Global equity markets have been sold down heavily in response with the US S&P 500 dropping 8.8% and British FTSE falling 5.3%. The Australian market has opened 5.4% lower.

Implications of overnight events

The breakdown of the financial sector rescue package has increased the risk of further failures in the global financial system, with the additional difficulties being reported by European based institutions providing evidence of the extent to which the financial crisis has spread. The blocking of the rescue bill has left the US Treasury with limited scope to initiate further bail-outs of financial institutions that may come into difficulty in the future.

Clearly the blocking of the bill was bad news for share markets and the global economy and some decline in share prices was warranted as a result. However, much of the decline in share prices has been due to ‘panic’ selling, along with forced selling by those who hold margin loans and other instruments that necessitate selling when certain barriers are breached. For those investors not forced to sell, history suggests investment positions should be maintained following sharp corrections in prices.

Although Monday night’s events may have extended the length of the financial crisis, Hillross remains confident that conditions will ultimately be stabilised. There will no doubt be a period of much slower growth in lending, as a result of the difficulties being faced by global financial institutions, which will cause much slower growth in business and economic expansion particularly in the US. However this economic slowdown is now already built into share prices. Last night’s sell off in global equity markets has pushed values down to levels that would only be rational if there was a prolonged and significant downturn in corporate earnings.

There also remains strong hope that the rescue bill will still be implemented in some form. The House of Representatives vote on the bill was close (228 against versus 205 for) and efforts will no doubt be high in coming days to attempt to find a resolution. If successful, the implementation of the package may act as a circuit breaker and restore some badly needed confidence in the financial system.

The failure of the acceptance of the rescue package has also increased the likelihood of some form of coordinated action by central banks around the globe to ease monetary policy and reduce interest rates. Lower interest rates would lead to a rise in bond prices for fixed interest investors, improve relative share market valuations and create a more favourable trading environment for businesses.

The Australian equity market

Australia still remains somewhat immune from much of the risks that have triggered the global financial crisis. With corporate profitability still healthy, the banking sector prudentially sound and ongoing growth in export demand being fuelled by Asia, Australia remains better positioned than many developed markets. As share prices in Australia have largely tracked overseas markets lower, share price valuations here would appear to be now particularly cheap. Further volatility in domestic share price should be expected, however with average dividend yields now approaching 5.5%, investment strategies with a focus on long-term investment earnings rather than short-term capital growth may be rewarding.

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