The purpose of this note is to summarise and explain the events that occurred at the end of last week. In this regard, there is likely to be more volatility over the next few weeks.

 

Below is a short summary – most of which I am sure you have read about in the newspapers or seen on TV.

Australian stocks fell last week, following declines on world markets, on concerns higher borrowing costs linked to the woes of the US housing market will halt the four-year rally in shares. The S&P/ASX 200 Index slid 5.3% to 6,082.9 as at the close of trading Friday, the biggest weekly decline since December 1987, amid concerns that corporate deals financed by borrowings will collapse as corporate bonds rise. The decline took the index, which is still more than 22% higher than it was 12 months ago, back to where it was in early April this year. (Source: Fidelity Investments)

1. Valuations Attractive

While there were some disappointments, most companies are meeting or beating estimates. Interestingly despite the panic over the US financial sector, earnings have overall come in slightly above expectations and the financials that did miss significantly, were mostly at the smaller end.

2. Interest Rate Environment Supportive Despite Risk Re-Pricing

US ten year bonds are back under 5% (4.8%) and Fed hike risk is now almost non-existent. Despite the recent panic, credit is not drying up. It is merely becoming moderately more expensive.

3. Corporate Balance Sheets Are Strong

US S&P 500 one year forward PE is now at 14.6 x. The UBS US team sees fair value in the 15x to 16 x range. The sell-off has also been quite indiscriminate; many stocks with no relation to housing, sub-prime, or LBO speculation have declined significantly despite beating EPS estimates.

A weakening of private equity bids will allow S&P 500 companies' to acquire private and smaller companies' on favourable terms.

What does this mean for you?

The general consensus is that interest rates in Australia will most likely increase in the short term due to concerns over inflation. We know that investing in stock markets can be volatile. What also seems certain is that the equity risk premium exists for those that are invested in shares.

We would suggest that you remain focused on the end goal and that is to ensure that over time, your investments outperform the value of your expenses.