Market volatility – Frequently asked questions
So what's the best course of action in times like these?
Where to from here?
What is a sub-prime mortgage?
What has happened to the US sub-prime mortgage market?
How has it impacted the global markets?
What does all this mean for Australian investors?
What is the best course of action for my investments?
Can we expect market volatility to continue throughout 2008?
Is the sharemarket still a good investment opportunity?
So what's the best course of action in times like these?
Before you make any major changes to your investment strategy, it's important to remember that this isn't the first time markets have experienced this sort of activity.
In 1991 we experienced the recession 'we had to have'. In 2000 we experienced the 'Tech Wreck'. In 2001 the attack on the World Trade Centre made a significant impact on our markets. And in 2003 the US invasion into Iraq caused a dip.
Equally important to remember is that in each and every example quoted above, the market recovered and went on to new, all-time highs - often within a relatively short period of time. And while nobody can know the future, it's likely that markets will follow a similar pattern this time.
While selling now may make you feel more comfortable because it means you won't be exposed to any further losses, it also means that you won't be exposed to any gains if, and when, the market recovers.
In other words, allowing a short-term view to influence your long-term investment strategy could be a costly mistake.
Meet with your adviser so that you can discuss how current market fluctuations are affecting your investments. Together, you can take this opportunity to review your risk profile, your original financial plan and, if necessary, also review your investment options to ensure you are comfortable with the plans we have in place.
A sub-prime mortgage refers to type of mortgage that is granted to borrowers with lower than average credit ratings. Due to the deficient credit the borrowers tends to be ineligible for conventional mortgages as they have a higher risk associated with the loan. Higher interest is charged on these loans to compensate for the risk.
What has happened to the US sub-prime mortgage market?
In late 2006, the US saw a sharp rise in defaults associated with sub-prime mortgages. With sub prime mortgages making up more than 20% of the entire mortgage market in 2006, the increasing rate of mortgages in 90-days delinquent or in foreclosure proceedings began to cost the US economy.
Following this over 20 subprime mortgage lenders failed or filed for bankruptcy. These bankruptcies cause a general decline in mortgage company stocks creating a general panic in the housing market as subprime lenders were a major catalyst in the housing boom in the US.
By early this year major banks and other financial institutions have reported losses of approximately U.S. $100 billion. The Economist predicted that the US has suffered $200-300 billion in defaulted loans in 2007. As a result of these losses, nervous investors with investments in funds related to the subprime mortgages and lenders caused further panic on the share market. The losses and consequences of the US subprime markets in 2006 caused global financial crisis within a year.
How has it impacted the global markets?
In a modern open economy, a country's finances are often dependent on international development. Contagion is the idea that a financial crisis in one country is very likely to cause a crisis in another. Companies in a stable economy would or could be denied financing simply because another economy in the region is failing.
The effects of the subprime crisis spread beyond the US and disrupted global financial markets as investors were forced to re-evaluate the risks they were taking and credit became harder to obtain. The increase in risk premiums and reduced capital liquidity global credit markets caused increased volatility in the money markets.
Many economists have predicted that the full impact of the US sub-prime mortgage market fallout is yet to be felt. The threat of a recession in the US is also a factor to be considered in the coming months.
What does all this mean for Australian investors?
It is clear that Australia is not immune from the fall-out emanating from the US sub-prime crisis. At this stage the recent events coupled with some impacts felt close to home such as the Centro fund suspensions, still have investors anxious.
The good news is that Australia is well placed to absorb a slowing in the world economy which may be caused by a more protracted US slow-down. The fundamentals in the Australian economy are strong. The financial sector has coped well with recent international market volatility.
Australia’s economic growth and its share market will be impacted by the resources boom with China and India playing major roles in the advancement of this sector, an independent Reserve Bank that can help manage inflation and interest rates and time around.
The slowdown in the US will not be enough to force Australia into recession; it will out of our economy and possibly leave interest rates more stable.
What is the best course of action for my investments?
Over the long term markets have historically trended upward regardless of momentary downturns as cyclic theory of financial crises have indicated. It’s also important that you consider all the consequences of making any changes to your investments.
Selling your investment during a period of poor performance may protect your net worth in the short term – but it may stall or hamper your longer-term wealth should markets go up again while you remain uninvested.
In times of market volatility, it’s understandable that you would feel nervous; however it’s even more important not to panic or be distracted from your long-term investment goals.
Historically, when sharemarkets have suffered downturns, these have been followed by sharemarkets highs over the long term. Understanding that sharemarkets rise and fall can help ease the nerves during times of short-term volatility and remind you of your long-term goals.
Speak to your financial adviser to help you understand what impact this recent volatility may have on your investments. They will help with making any necessary changes to ensure you are on the right path...
Can we expect market volatility to continue throughout 2008?
It is largely speculated that volatility will continue throughout 2008. It is predicted that the financial market landscape over 2008 will most likely have two distinct profiles. The first half of 2008 is likely to show economic weakness and lack of risk appetite among investors, while the second half is likely to show relatively strong upward economic momentum and a healthier appetite for risk.
Is the sharemarket still a good investment opportunity?
Investing into the sharemarket is an effective long-term investment strategy. For further information, please contact your financial adviser.