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Thursday, January 17, 2008

The Global Correction: What's Going On?

Global markets have taken a battering over the last week, and Australia certainly has not been immune. We are increasingly appreciating that the air of immunity that has hung over us for over a decade has been somewhat intoxicating.

Australian shares are now down more than 14 % from their recent peak in November. Another way to put this is that average share prices have given up most of 2007's stellar gains and have fallen to last quarter of 2006 prices. The shareprice of Qantas has notably been one of the casualties, with the few that have benefitted being food producers, such as AWB.

Already the tough-nut, hardened experts are shrugging off the "correction", noting that when shares fall 20 % in a day, that's a crash.

Nevertheless, Australian shares have fallen slightly more than US shares, despite the fact that the Australian economy seems to be in far better shape. Unemployment in the US is rising, and new home approvals is at the lowest level in 27 years.

Both Australia and the US are indeed suffering inflation, led by rising food and energy costs. Growth indicators are far stronger in Australia, but unsustainably so (for example, retail sales and job vacancies growth of the order of 7 % annually). Australian banks and other financial institutions seem in far better shape than similar institutions in the USA and indeed are somewhat less dependant on the US market than some would have us believe.

There are, however, warning signs. Those most clear are the sheer expanse of Australia's credit boom; our heavy reliance on our resources propping up other sectors; and as many of you are experiencing, rising interest rates and inflation are certainly burdens that we are having to take on the chin.

As Henry Thornton adeptly explains, "Equity markets are said to be driven by waves of fear and greed. While fear produces crash and greed causes bubble, markets in more normal times are also the best economic prediction machines we have."

Just possibly, Australia's greater correction so far may be signalling that the Australian economy has more slowing to do from this point than the US economy. Compared to the USA, growth has to slow in most places, even in China and India.

This does not mean either the US or Australian economy, or the Chinese economy need suffer a recession. Growth has to slow in all three countries, and in many others, because recent growth is unsustainable.

The message of the markets is that this slowing is underway. If we are lucky, adjustment will be mild and will be achieved with minimal damage in terms of lost jobs, bankrupt businesses and social and political unrest.

Despite the financial market trembles, the Reserve Bank should help Australia achieve a soft landing with at least one more rate hike next month. The Rudd government needs to tighten spending substantially - having "found" a surprise saving of $3billion from "underspending" in health care, education and infrastructure from the Howard Government, Rudd has been helped in it's quest for finding savings of $10billion.

The much discussed drop in consumer confidence should be welcomed as a sign that Australian households are rational, and some spending restraint is highly rational now - better late than never.

Simon Turner simon@marquetteturner.com.au

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