Market Wrap - Week Ending Friday 25th Jan 08

Since the market topped at the end of October 2007 our market has dropped 20%, the 21/01/2008 bottom was a total drop of 23.5%. This article is to help explain what is going on and what you should do.
Market%20Wrap%20Pic%2025-1-08.gifThe cause of the recent decline in our market has in part been brought about by the decline in the US. Our view is that the sharp fall in US stocks were brought about by a sharp fall in the expectation for US operating earnings.  The US operating earnings fell from a peak of 24c for the June quarter of 2007 to a level of 19c for the December quarter of 2007. It is important to understand this last number is still a forecast. Most of the companies in the S&P500 have yet to report for the December quarter.

The situation with earnings is quite different in Australia. Whereas the US economy is weak, the Australian economy is strong. It’s quite obvious that some companies listed in the Australian equities market have suffered a negative impact from operations in the US. However, our measure of operating earnings for the Australian equities market grew some 20% in calendar 2007. We expect it to grow some 15% in calendar 2008.  Our fundamentals are also much better than theirs.

Over the past couple of years we have seen a massive increase in both people borrowing to invest and investing through geared products. Most of this has been through discount brokers where inexperienced investors have had little guidance as to how to invest. The fall on the 21/01/2008 was partly due to margin calls on investors, and investors having to close out short positions held through geared investments. We‘ve also seen a massive run on the managed fund products with investors redeeming these into cash, for fear of losing their entire investment. This also causes the fund managers to sell down their share holdings in order to raise the cash.

When combined together, all these factors cause the market to be sold off at an alarming rate. The good news is that the sell off on the 21/01/2008 will have shook out at lot of high risk and inexperienced investors making way for a recovery to start.  

Based on our model of the Australian equities market the fair value of the ASX200 on 21/01/2008 was 6347 points. This means that the market for the ASX200 on 21/01/2008 closed some 1160 points below fair value.

It’s obvious such a large level of discount is not rational in the circumstances of the Australian economy.  At the very least, the market was trying to discount Australian equities for the prospect of a major US recession after this style of the tech crash of the early part of this decade.  We may continue to discount a US recession for some time yet. However, experience tells us that by the time we reach the second half of calendar 2008, it is likely we will see a return to fair value.

Until next week.