How low can it go?
That's the question on the lips of every trader and investor as Australian stocks, and those across the Asian region, tumbled again yesterday.
As pessimism continues to take hold, there is a growing band of traders punting the local bourse will again break below 4000 and possibly push as low as 3500 if European leaders cannot contain the Continent's debt crisis.
While far less damaging than the bruising encounters of a fortnight ago, yesterday's falls unwound the timid gains notched up last week as European leaders continue to bicker and dither over how to prop up Greece and save the euro zone.
Rather than take the running, and put Greece into a controlled or orderly default, European politicians and the European Central Bank are at odds about exactly what to do.
As the US Treasury Secretary, Timothy Geithner, commented: "What is very damaging from the outside is not the divisiveness about the broader debate, about strategy, but about the ongoing conflict between governments and the Central Bank, and you need both to work together to do what is essential to the resolution of any crisis."
So why should any of this worry us? As we keep hearing, from our politicians, our corporate leaders and the nation's economic pointy heads, we're hooked into China, a nation in the throes of perhaps the greatest economic miracle in history.
It matters because of the potential impact an unruly Greek default would have on international banking.
Exactly what the impact will be is too difficult to tell. And it is that fear of the unknown - the extent to which the shockwaves will reverberate through global banking - that is spooking investors.
As we learnt three years ago, global banking is interconnected in ways that even those running the banks seem incapable of fully comprehending.
European banks not only have extended trillions of euros in loans to the stricken PIIGS (Portugal, Ireland, Italy, Greece and Spain) but they have traded and exchanged an unknown amount of derivatives with each other and banks around the world, based on those debts.
Derivatives such as credit default swaps - designed to spread risk - have done exactly that. Originally intended to minimise risk, these unregulated trades instead have added to the uncertainty plaguing markets and hammering investor confidence.
A default could trigger insolvency within European banks. That may then affect other banks with exposure to European banks.
That fear of the unknown explains why Australian banks, with little direct exposure to European sovereign debt, again came under pressure yesterday. Westpac Banking Group led falls among financial stocks across the Asian region with a slide of 2 per cent. The three other local majors were hot on its heels. Perplexed Australian investors are now staring at what should be, theoretically at least, absolute bargains on the local bourse.
Blue chip companies that four years ago were trading on an average of 12 or even 14 times future earnings now can be bought for nine times next year's projected profit.
Even BHP Billiton, Australia's biggest company and the world's leading miner, is trading at just 9.5 times next year's projected earnings.
Although resources companies traditionally have traded at a discount to industrials, given the once fleeting nature of resource booms, this time there is general agreement that things are different, and that the boom has years to run.
At yesterday's $37.58 close, a 1.7 per cent drop, company insiders reckon BHP is priced for global recession despite every indication that demand from China will continue at current levels for the medium-term future.
Dividend yields are also incredibly attractive. The average yield across the ASX 200 is now sitting at a whopping 5.28 per cent. One of the highest average yields in the developed world, it is outdone only by the French bourse at 5.38 per cent and is way ahead of Wall Street, where the average yield on the S&P500 is just 2.18 per cent.
For the past two years, the Australian market has laboured under the weight of the strong Australian dollar, which has crimped offshore earnings from our bigger companies.
This time around, the dollar stubbornly has refused to go below parity despite the fears affecting global finance, which in previous times would have sent the Aussie plummeting.
So are stockmarkets out of touch with reality? Are the lemmings running too hard with the bears and sending stocks to unreasonably low levels?
The answer would have to be no. There is a perceived threat to the stability of global banking which politicians either are unwilling or unable to confront. As each day passes without resolution, that perception becomes closer to reality.
And while stocks appear to be attractively priced, the wildcard in both key ratios is "projected earnings". If the forecasts are overly optimistic, current share prices may be just right. And if earnings are lower than expected, dividends will be lower.
Those concerns about a repeat crisis in global finance have consumers eschew debt and restore their balance sheets, much to the alarm of bankers who have had to rein in forecasts on lending growth.
It has been repeated within the corporate world as well. After being bitten three years ago, American firms are holding 7.1 per cent of their assets in cash, according to data from the US Federal Reserve.
That's the highest level since 1963 and it doesn't include the substantial cash reserves held by many American companies' foreign offshoots.
Everyone, it seems, is hoping for the best but bracing for the worst.
Frequently Asked Questions about this Article…
Why did Australian stocks tumble and could the ASX really fall below 4000 or 3500?
The article links recent falls in Australian stocks to growing pessimism about the European debt crisis — especially uncertainty over how leaders will handle Greece. Traders are speculating the ASX could slip below 4000 and even toward 3500 if Europe cannot contain the crisis. The immediate driver is fear of the unknown and potential contagion through global banks, not necessarily Australia-specific fundamentals.
How might a Greek default or European debt crisis affect Australian banks and investors?
A Greek default could ripple through international banking because European banks have large loans to the PIIGS and extensive derivatives exposure. That interconnectedness raises fears of insolvency and knock-on effects. Even with little direct sovereign exposure, Australian banks fell on this fear — Westpac slid about 2% — as investors worry about global banking contagion.
Are blue‑chip ASX stocks good bargains after the recent sell‑off?
The article says many blue‑chip companies that traded around 12–14 times future earnings four years ago are now near nine times projected earnings, which can look like attractive value. For example, BHP Billiton was trading around 9.5 times next year’s projected earnings. However, the key risk is that those projected earnings may be overly optimistic; if earnings fall, current prices and dividends may not be as safe as they appear.
How attractive are dividend yields on the ASX right now compared with US markets?
Dividend yields on the ASX are described as very attractive: the average yield across the ASX 200 was about 5.28%, one of the highest among developed markets. By comparison, the average yield on the S&P 500 was roughly 2.18% and the French bourse was slightly higher at about 5.38%.
Why do resource companies still look promising despite market volatility?
While resource stocks typically trade at a discount to industrials because booms can be short‑lived, the article notes a general agreement that this resources boom could last for years due to ongoing demand from China. That outlook helps explain why some investors still see value in major miners despite market turbulence.
What impact is the strong Australian dollar having on company earnings and the market?
The article points out that a strong Australian dollar has weighed on offshore earnings for larger Australian companies over the past two years. Unusually, the Aussie has remained stubbornly near parity despite global financial fears that in past crises would have pushed it down, which continues to crimp reported offshore profits.
What role do derivatives and credit default swaps play in the current market uncertainty?
Derivatives such as credit default swaps were intended to spread and minimise risk, but the article says unregulated trading of these instruments has added to uncertainty. Because banks have traded unknown amounts of derivatives tied to sovereign debt, that complexity and lack of transparency is a major source of investor fear about potential contagion.
What key signals should everyday investors watch during this period of market stress?
Based on the article, investors should monitor progress on resolving the European debt crisis (especially Greece), corporate earnings versus the 'projected earnings' used in valuations, dividend sustainability, signs of contagion in global banks, and macro behaviours like consumers deleveraging and companies holding cash. The article notes US firms are holding high cash levels (about 7.1% of assets), underscoring caution across markets.
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