Market turmoil - For the investor

We are witnessing very stressful times in the local and international markets. After difficult times where growth asset classes produced negative returns, uncertainty in world markets has increased. Markets do not react well to uncertainty. It has been impossible to avoid the reports of massive swings in global stock markets (mainly down but there have been times of unprecedented gains too) and intervention of centrals banks around the world.

A world-wide problem

The current lack of liquidity (supply) in global credit markets was precipitated by the subprime mortgage crisis. A period of excessive individual and corporate debt levels, and risky lending and borrowing practices (particularly, but not exclusively, in the US) housing market. This caused a significant increase in subprime and variable rate mortgage defaults (beginning in late 2005). Borrowers had been encouraged into mortgages assuming that the housing market would continue to rise whilst believing they could always refinance on more favourable terms. This all came to an end when the housing bubble burst resulting in the collapse of the largest mortgage lenders in the US, Fannie Mae and Freddie Mac. (If you have every wondered how these organisations got such unusual names, see our article.)

The US is not alone in these troubles. Banks, financial institutions and investment markets in the UK, Europe and many other countries have also suffered significantly. As risk spread around the world, companies have been reticent to lend to one another, thus the global credit crisis.

Clearly, Australia is embroiled in these problems. Some high profile organisations have experienced huge share price reductions due to the belief that their models are similar to some of the US investment banks. (However, compared to the US and the United Kingdom, the Australian financial sector has very low levels of debt and exposure to distressed mortgage backed securities). We have seen panic selling on the ASX, a large reduction in interest rates and the Government guarantee on bank deposits with the unintended consequences that followed.

For the investor

It is not possible to accurately predict the swings of markets but it is important to remember that markets have always moved in cycles. Many fund managers and participants believe that very strong value propositions are emerging. Whilst there is a great temptation for the individual investor to act quickly, it is now the time to remember the basic rules of investment.

Published : 20 November 2008