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Last year was the worst year on record for Australian shares, with the market losing 43 per cent. It’s reasonable to hope that 2009 will be far better. But will it?
Right now, the global and Australian economic situation provides little comfort.
The global financial crisis and the oil shock earlier in 2008 have led to an unprecedented synchronised recession in the US, Europe, Japan and in many emerging countries.
The Australian economy has already stalled. Unemployment looks like it has much further to rise and profits will likely fall sharply this year. And the uncertainty regarding the economic outlook is greater than normal given the unprecedented blow to the global financial system and the pressure to reduce debt levels.
While the uncertain economic and profit outlook suggests it is too early to conclude that shares have bottomed — and whether they have or not the next few months is likely to remain rough — there is good reason to expect shares to end this year higher than they started.
Firstly, Australian shares are trading on earnings and dividends yields that historically have been associated with strong future returns.
The dividend yield grossed up for franking credits is now over 8 per cent and this compares to bond yields of just over 4 per cent and cash yields of around 4 to 5 per cent. Sure, profits are likely to fall over the year ahead and this will lead to some reduction in dividends, but cash and bond yields are likely to fall further as well.
Secondly, while the current global financial crisis and associated economic slump are unprecedented in the post-war period so too has been the monetary and fiscal easing by governments around the world.
The policy response has been far stronger than was the case in the 1930s or in Japan in the 1990s and should start to drive a recovery later this year and/or in 2010.
If global growth prospects start to gradually brighten through the second half of 2009 and into 2010 as we expect, shares are likely to move up in advance just as they led the economic cycle on the way down.
Thirdly, extreme falls like that seen over the past year are often followed by good rebounds.
The previous two worst years in Australian share market history were 1930 when shares fell 33.9 per cent and 1974 when they fell 32.2 per cent.
But the interesting thing to note is that extreme falls are often followed by good rebounds: 1931 saw Australian shares rise by 11.3 per cent, followed by a 19.9 per cent gain in 1932, and in 1975 they rose by 48.5 per cent.
Finally, bear markets come to an end at a point of maximum bearishness and right now there is lots of bearishness around. This is reflected in the huge build-up of cash in bank deposits. In other words, there is plenty of fuel building up on the sidelines to power an eventual recovery in shares.
Given the greater than normal uncertainty regarding the depth of the global recession and the timing of the recovery, trying to put a level on where the Australian share market will end 2009 is little more than guesswork. But my best guess is 4,500 for the All Ords.
Shane Oliver is head of investment strategy and chief economist at AMP Capital Investors.
