Tragic events in Japan and the Middle East caused a huge spike in volatility during March. The stock market has proved to be remarkable resilient in the face of potentially higher oil prices caused by uncertainty due to the social unrest in the Middle East coupled with the devastating Japanese earthquake and subsequent tsunami and nuclear reactor issues. The key question on investors’ minds is how these events have affected the overall riskiness of the global share markets.
The main reasons that share markets bounced back after these events were assessed are as follows:
- Japan is the world’s third largest economy and whilst devastating in the short term natural disasters ultimately result in a lot of rebuilding activity which stimulates the economy. If the past is anything to go by then investors should look at what happened after the Kobe earthquake in 1995. At that time the Japanese stock market was weak for about 6 months before it commenced a sustainable rally that resulted in higher share prices than prior to the earthquake.
- The fact that Japanese economy is relatively closed has limited the effects on the global economy. Imports in Japan account for only 10% of their Gross Domestic product and are only 4% of global imports.
- In the long term Australia may benefit because Japan is still Australia’s second largest trading partner behind China. Japan is a huge importer of Australian coal and iron ore for use in its steel industry and demand for these products during the rebuilding phase should pick up.
- US economic growth is showing signs of improvement with falls in the unemployment rate helping to increase confidence.
At home the Australia dollar continues to power ahead setting new record highs against the USD. Today the AUD is trading at 105.5 US cents with some analysts calling for $1.10. Personally I think that now is a good time for investors to revisit their international exposure and consider rebalancing their portfolios to increase their allocation to non-AUD denominated assets. When doing so investors might want to consider utilising alternative assets in order to increase their overall diversification. Australia’s two speed economy is in danger of becoming a one speed economy totally dependent on the resources sector. This will have significant impacts on property prices through higher inflation which will result in higher interest rates. While the resources boom continues to strengthen I believe that this will create a very difficult environment for the Reserve Bank and the government to manage the economy.
Finally the loose monetary policies (printing of money) of the developed world are the fuel behind the majority of the developed world’s economic growth. Early signs of economic pickup are encouraging but it seems unlikely that this economic growth is self sustaining. The key risk beside increased inflation is that the stimulus created by government spending might be withdrawn too early as demands escalate for governments to be fiscally responsible. We do not want the government to take away the punch bowl just as the party is getting started but if governments wait too long the risk of inflation increases. There is no doubt that this will be a delicate balancing act.
Michael Lannon
Founder & Executive Director