By David Haintz

David Haintz is a top of mind adviser who has demonstrated exceptional initiative during these uncertain times by developing the following commentary for his client base. David is Principal, Private Client Adviser, Shadforth Financial Group.

August 5, 2011

The events of the last few days have many people feeling understandably nervous and we are seeing some emotive headlines within the media.  Given this, I thought it appropriate to put some of this in context for you.

The S&P 500 (a measure of US shares) fell 4.78% last night to 1,200.07, which is the biggest one day fall since December 2008.  The loss last night means that the recent losses are officially a ‘correction’, which is defined as a fall greater than 10%.  While the events of the last few days are unnerving and certainly evoke emotion, it is worth noting that the closing price of the S&P 500 at the end of August 2010 (almost one year ago) was 1,049.  This compares to the current level of 1,200.07.  It may surprise you given the doom and gloom of the media, but US shares are actually up 14.4% over the last year.

For the Australian market, the ASX 200 closed today at 4,105 points, a fall of 4%.  The closing value at the end of August 2010 (almost one year ago) was 4,404.  This means the Australian market has fallen approximately 6.8% over the last 12 months.   This does not include dividends that have been paid over the past year.

It is unlikely you will see these numbers in the media, which will instead present headlines promoting a concentrated focus on the very short term.

Sovereign debt issues

The sovereign debt issues in Europe and recent poor economic data out of the United States have led to considerable market volatility in recent days and months.  The sovereign debt issues in Europe cross two complex and associated issues.

The first issue is a solvency issue. Greece is effectively insolvent and Portugal and Ireland have potential solvency issues. The good news is that the European Union and the European Central Bank have finally recognised the insolvency issue in Greece. The new Greek bailout package is a fundamental step in the right direction. The package materially reduces Greece’s financial burden via the extension of loan terms and the reduction in interest rates; these measures were also extended to Ireland and Portugal. This reduction in Greece’s debt burden is a fundamental step in putting Greece on a path to sustainability.

The second issue engulfing Europe is a potential sovereign debt liquidity crisis affecting larger European countries, particularly Italy and Spain. It does not appear that either Spain or Italy are insolvent, however a collapse in bond market confidence could push yields on sovereign debt to levels that create a true liquidity crisis. Monetary union presents particular challenges to addressing this situation. For a country that has its own currency and an independent central bank able to readily print money, this situation would be addressable. In such circumstances the central bank could print money and buy bonds on the open market to drive down yields and monetise government funding requirements.

It is unlikely that these liquidity issues will result in a financial Armageddon scenario and that correct policies will eventually be pursued. However, there are differing views on the correct path of action and therefore we could see a sustained period of considerable volatility until this is resolved.

US debt ceiling

The recent decision to raise the US debt ceiling has removed considerable risk in the short term and the US should take action over the next few years to ensure it is on a sustainable long term fiscal path. Economists are now focusing on the strength of the US economy. All eyes will be watching the release of US unemployment data tonight, with a weak number or a decline meaning the US economy has potentially entered a second recession.

Australian economy

Despite the economic turmoil in global markets, the Australian economy remains in relatively good financial health thanks to a strong resource sector. It should be noted that Australia has the strongest GDP growth, lowest unemployment, and strongest AAA rated balance sheet in the OECD.

The Australian Bureau of Statics yesterday released data that showed Australia produced a $2 billion-plus trade surplus for June, resulting in a $22.4 billion surplus for the 2011 financial year. This is the biggest surplus in raw terms over the 40 year period that records have been kept.

Economists have commented that the unusually buoyant trade conditions for Australia are a result of near-record commodity prices for much of the country's resources and help explain why the central bank can't rule out further interest rate rises.

The official interest rate in Australia currently stands at 4.75 percent, which is significantly higher than most other developed countries. This provides the Reserve Bank of Australia (RBA) with scope to cut official interest rates to stimulate the domestic economy. Most major western countries cannot cut interest rates dramatically as they are already near zero and governments cannot provide great wads of fiscal stimulus the way they did in the Global Financial Crisis (GFC) as they are deeply in debt.

Recent volatility in global markets is expected to result in the RBA putting off interest rate hikes indefinitely, with the possibility the next move in interest rates may be down. Some economists are even suggesting that the RBA may hold a special meeting next week to cut interest rates. This would be similar to what happened in 2008 during the GFC, when the RBA made a series of “emergency” rate cuts.

Any reduction in interest rates would provide a boost to the struggling retail sector, which is suffering from weak discretionary spending and competition from online stores.

Portfolio management

In times like this I am reminded of the quote below from Peter Lynch, the very successful investor with Fidelity Investments.

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”

We believe that now, as always, is the time for investors to remain calm and stick with their long term strategy.

It is impossible to pick the bottom of the market cycle and it always seems ‘darkest before dawn’. It takes a great deal of courage to invest when shares are at their cheapest valuations. Rather than trying to time markets, a strategy of agreeing on a certain percentage of a portfolio being maintained in shares, property and fixed interest, combined with systematically rebalancing is a sensible strategy. This allows one to consistently buy more of an asset class when it is low and to reduce it when it is high. It takes the emotion out of the process.

Estplan commends David on his proactive approach and client communication skills. We would love to hear from you on how you are dealing with the market uncertainty. Send us an This e-mail address is being protected from spambots. You need JavaScript enabled to view it .