Sharemarket a sideshow, not the barometer

AT TIMES like these, much of the media tends to cater to people who enjoy a good panic. The sky is falling and the proof is that billions have been wiped off the value of shares in just the past few days. Which makes me wonder how I've survived in the media for so many years. I hate panicking. So I'm always looking for contrary evidence. I just have hope there's a niche market of readers who prefer a sober assessment.

A bane of my working life is the way people imagine the state of the sharemarket to be far more important than it is in the workings of the economy. Our response to big falls in the sharemarket is based more on superstition than logical analysis, and a lot of people who should know better are happy to pander to the public's incomprehension.

We have a kind of race memory a relic from the 1930s that tells us a sharemarket crash is invariably followed by an economic slump. It ain't. As the Nobel prize-winning economist Paul Samuelson once quipped, "the stockmarket has predicted nine of the past five recessions".

Do you remember the crash of October 1987? No, probably not. There's no great reason to. It was the biggest fall on Wall Street since the Great Crash of 1929. People were panicking in 1987 much as they are now.

A commentator senior to me predicted it would lead to a global depression. In my comment I predicted no worse than a world recession. Fortunately, my thoughts were billed as The End Is Not Nigh.

Turned out we were both way too pessimistic. What transpired? Precisely nothing. Neither in America nor here. In Australia, the economy motored on for more than another two years before a combination of the subsequent commercial property boom and a lot more increases in the official interest rate finally brought us the recession we had to have.

The trouble with taking the sharemarket as your infallible guide to the economy's future is that it is itself prone to panic. Its mood swings between greed and fear. Like all financial markets and like the media it acts in haste and repents at leisure. You can panic today because you can always change your mind tomorrow.

That's fine when onlookers don't take the sharemarket's antics too seriously. When they take its mood swings as authoritative, however, their reactions can cause those antics to have adverse effects on the "real" economy of spending and jobs that we inhabit.

In other words, what's important is not the ups and downs of the sharemarket, but the way we react to them.

In 1987, a lot of ordinary people who'd bought shares during the boom rushed out and sold them thus buying high and selling low, precisely the opposite behaviour to the way you make money from shares. But the public soon shrugged off its anxiety and it wasn't long before the market recovered its lost ground.

Of course, a lot of things have changed since that great non-event of 1987. Then, the link between the sharemarket and our daily lives was quite tenuous. These days, the link is much stronger thanks to the advent of compulsory superannuation which has given most of us a fair stake in the sharemarket and the baby boomers' proximity to retirement. These days a sustained fall in share prices knocks a noticeable hole in people's retirement savings. That hole will refill in time, but who's to say how long it will take?

Another difference with 1987 is that, this time, the sharemarkets in Wall Street and Europe really do have things worth worrying about. The American economy is quite weak and, although it's unlikely to drop back into recession unless Americans will it to, it's likely to stay pretty weak for the rest of the decade.

It's the Europeans who have by far the most to worry about, with so many heavily indebted governments locked in to the euro and banks that are still in bad shape.

But yet another thing that's changed since 1987 is our economy's reorientation from America and Europe towards China and the rest of Asia. Much of the fear that rises in our breasts on hearing of crashing sharemarkets is our unthinking conviction that what's bad for them must be bad for us.

It ain't so not unless we unwittingly make it so. There never was a time when our economy was less dependent on the US and Europe than it is today. Well over half our exports go to Asia, with surprisingly small proportions going to the US and Europe.

It's true we're quite dependent on China, but its problems are all in the opposite direction to the North Atlantic economies: it's growing too strongly and could use a bit of a slowdown. There never was a time when China was less dependent on the US and Europe than it is today. The notion that the world's second-largest economy lives or dies by its exports to the North Atlantic is silly.

But if all this is true, why does our sharemarket still take its lead from Wall Street? Because of its tendency to herd behaviour. By tacit agreement, what Wall Street's done overnight acts as a signal to all Australian players of the direction in which our market will be travelling.

But what holds in the short term shouldn't hold forever. Eventually, the price of a BHP Billiton share will reflect the profit-making prospects of BHP and they're still very good.