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The last 12 months have proven to be a testing time for most investors, especially when compared to recent years. A period of strong world-wide economic growth and double-digit returns on global sharemarkets has recently been replaced with significant volatility and disappointing short-term results. Volatility in the global markets was triggered by the US sub-prime crisis.
Ask an expert
Erick Siegloff, Chief Investment Officer for ING Investment Management, discusses fund performance and investment strategy for ING Investment Management.
What is the sub-prime crisis?
The well documented global credit crisis has been the catalyst for much of the turbulence. We have seen a number of banks and other financial companies fall into difficulty after announcing substantial losses. In addition, global economic growth has slowed and interest rates have fallen in the US. The combination of these factors has resulted in many headlines blaming the US mortgage industry and, in particular, the troubles of the sub-prime mortgage sector, for the downturn.
Sub-prime mortgages – or home loans made to borrowers with poor credit histories – have become a problem when the introductory rate is reset to the market rate after a ‘honeymoon’ period. In the US, market interest rates rose dramatically from 1% in 2004 to 5% in 2006, and many borrowers simply did not have the resources to meet their increased interest obligations.
As the number of mortgage defaults grew, credit markets became more cautious and the impact spread across a broad spectrum of asset classes and global markets.
US economy
Throughout the past year, weakness in the US housing sector has affected other areas of the US economy. The US economic growth rate slowed and, in response, the Federal Reserve cut interest rates from 4.5% to 2% in an attempt to stimulate economic activity and confidence. Doubts about a US recession remain, and the sharemarket has lost 15.35% for the financial year. The reduction in interest rates aims to encourage economic activity, while an increase in interest rates aims to slow economic activity.
Australian economy
Global events have also had an impact on the Australian sharemarket, with a loss of 13.67% of its value for the year. However, the Australian economy remains reasonably robust with employment and domestic demand being sources of strength. ‘De-coupling’ is apparent, meaning that Australia is becoming less reliant on the US and more reliant on Asia. Strong consumer spending has continued and this has fuelled inflation. To keep inflation within its target levels, the Reserve Bank of Australia has increased official interest rates from 6.25% to 7.25%. De-coupling refers to reducing the correlation or dependency between two markets, e.g. the US and Australian economies. Over the past year, cash and fixed interest (returning 7.34% and 4.42% respectively) both experienced positive returns. On the other hand, the Australian listed property sector has been hard hit by the global credit crisis and has fallen by 36.35% for the year.
Global economy
The credit crisis emanating from the US has affected many developed economies and the international sharemarkets have dropped an average of 15.16%, most notably in Europe (-19.63%), Asia (-4.33%) and Japan (-25.67%). However, emerging markets continue to prosper and provided returns of 1.65%. As most of the global economy has suffered a shaky ride over the past year, it is important for investors to review the suitability of their portfolio for their personal needs, objectives and timeframe.
What should I do?
So when considering your own response to the current market, it is useful to compare the performance of different asset classes over a long period of time. For example, most of us know how exceptionally well Australian shares have performed over the past five years. However, click here to view the graph that shows over the past 25 years there have been periods when this asset class underperformed compared to international shares, property and sometimes even cash or fixed interest. It is important to recognise that financial markets are cyclical and no asset class will consistently be a top performer.
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