The Australian sharemarket had a poor month in May, with the All Ordinaries Index falling 7.9% to close at 4,453.6 points. International markets were also down as fears of a Europe led debt crisis affected global financial markets.
The Dow Jones Index closed down 7.9%, the FTSE closed down 6.6%, the Hang Seng closed down 5.0% and the Nikkei 225 closed down 9.9% for the month.
The European debt crisis has emerged as a major issue impacting upon global markets. During the month a ‘bail out’ package was negotiated within the European Union to rescue Greece from a potential default on its sovereign debt.
With the EU countries trading the one Euro currency, our view is that over the long-term there will be a reallocation of wealth amongst the European nations. Put simply, the stronger European nations of Germany and France cannot afford to allow the weaker countries to fail in our view. However, political sensitivities may result in continued market volatility for the coming months.
In domestic news, May saw the release of the long awaited Henry Review of taxation and the Federal Budget for 2010/11.
The budget has sparked a nationwide debate into the proposed ‘Resource Super Profits’ tax. Fundamentally, our view is that the tax in its current form is poor from an economic perspective and will lead to less investment in the industry.
We expect this issue to be hotly contested leading into the Federal election later in the year. We would not be surprised to see the resources industry flex its muscle by slowing production whilst the tax is being debated.
The pullback in the Australian sharemarket now sees shares trading at a long-term discount from a price-earnings perspective (currently 12x average PE ratio compared to long-term average of 15x). With economic news still robust, we expect the market to recover swiftly in the second half of 2010.
Key issues of European debt and the ‘Resources Super Profits' tax may play havoc amongst global markets in the immediate term. As a result, volatility will be present in all markets for some time. However as we saw in 2009, sharemarkets have the capacity to recover very swiftly once market participants are comfortable that no more bad news is to come.
In our view, the key downside risk to the Australian sharemarket is a slowing of economic growth in China. We don’t expect the China Government to overreact in its attempts to slow a booming economy and property market. Rather, we expect China to achieve a gradual slowing of the economy through sound Government policy.
Interest Rates
The Reserve Bank of Australia again raised the interest rates in May. The RBA cash rate is currently 4.50% per annum. Interest rates are expected to remain on hold whilst the recent economic uncertainty in Europe plays out.