Funds Update

Market Review

After five straight years of exceptional returns, we’ve seen increased media coverage of the Australian sharemarket over the last couple of months. While this can be a nervous time, it’s important to ride out the volatility and remain focused on your destination.

In a nutshell, the volatility witnessed in markets of late stems from the sub-prime mortgage meltdown in the United States. But what exactly is the sub-prime crisis and how did it trigger a reaction here in Australia?

What is sub-prime?

The crisis was triggered by mounting defaults by borrowers in the US with poor credit histories- ’sub-prime’ borrowers. These borrowers were not ‘prime’ candidates for loans and therefore carried greater levels of risk and were deemed to be more likely to default, or not pay back their loan on time, or at all. As a result of the mounting sub-prime borrowers’ defaults, credit for further loans has been squeezed. This credit squeeze has rapidly spread around the world, including to Australian home loan providers who borrow on the US capital markets to fund their business.

The sub-prime issue, combined with the decline in the US housing market and fears that the US economy may fall into recession, has caused sharemarkets around the world to decline. The US economy is the world’s largest economy and any downturn there tends to have a knock-on effect globally.

Australia is well positioned

We are likely to see a continuation of this volatility for a while yet as the market digests developments in the US and whether there will be impacts on the other main engines of growth, China and Asia.

The good news is that Australia is better positioned than many other markets to weather the storm. Investment diversification has buffered Australian investors to a certain extent, and, contrary to the US, the Australian economy is actually quite healthy. With activity still strong, it’s almost too healthy, causing inflation to spike higher and the Reserve Bank (RBA) to increase official interest rates to 11-year highs.

Learning to live with volatility

Chart 1 demonstrates that the last few months have really just been a blip in a long-term trend of positive returns.

Over the past 20 years the Australian sharemarket has experienced many ups and downs. Importantly though, on every occasion when the market has fallen it has always bounced back to new record highs.

For superannuation investors who have a long-term horizon, it’s always a wise idea to review your investment strategy periodically to check it’s on track to meet your investment goals. But if you have a sound strategy, such as a diversified portfolio of growth assets, the most important thing to do is just sit tight and stay with it.

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