What’s behind the sharemarket sell off, and when will it turn around?

Australian shares look like ending the week on a positive note, with a 4% rise in early trade. But make no mistake – it has been another tough week for Australian investors, who were whacked by 5.4% fall on Thursday that knocked $60 billion off the value

Australian shares look like ending the week on a positive note, with a 4% rise in early trade. But make no mistake – it has been another tough week for Australian investors, who were whacked by 5.4% fall on Thursday that knocked $60 billion off the value of the total market.

But what’s behind the falls? And when will the volatility end?

Time for a quick SmartCompany Q&A.

I thought things were looking up. Obama is almost in the White House, banks are lending to each other a bit more, Ken Henry says we’re not going into recession… why are my shares still getting pounded?

The magnitude of the falls this week have been a little bit surprising, particularly given the global sense of excitement generated by Barack Obama’s victory in the US election. Unfortunately, one bit of good news can’t outweigh the avalanche of bad news pointing to rapidly deteriorating economic conditions.

CommSec’s chief equities economist Craig James argues that this year’s sharemarket falls are partly about Australia following the leader. He points out that the key global sharemarkets are all down by around the same magnitude over 2008. The All Ordinaries is down 43%, the US S&P500 is down 42%, the German Dax is down 42% and Japan’s Nikkei is down around 43%.

But what’s driving these falls?

It’s all about the “R” word – recession. Investors around the world are watching their economies slide towards a prolonged downturn and this is forcing them to reassess their prospects for company earnings. Here’s a bit of a snapshot of how they are thinking:

• Banks? They’re already losing money from company collapses and mortgage defaults and this can only get worse. Time to sell.
• Miners? A recession will drive down demand for commodities like coal and iron ore. Sell.
• Manufacturers? They’ve been stuffed for years, we’ll pass thanks.
• Retailers? No thanks, not with consumers shutting their wallets so tightly.
• Infrastructure? Too much debt, get rid of them.

These investors are a negative bunch, aren’t they?

They are, but who can blame them. Make no mistake – this is the worst financial crisis in 80 years. Overnight, Germany officially entered recession, while a report from the OECD said that it appears the 30 leading economies of the world appear to have entered recession. As Robert Gottliebsen argues today, the sharemarket is acting as a sort of early-warning system for the wider economy.

Geez, I get it, things are bad. Is there any light at the end of the tunnel?

Well, Wall Street did rebound overnight by almost 7%, although at one point during the night shares fell to their lowest point in more than five years. Most market watchers put the late rally down to bargain hunting, as investors scoop up solid companies at fire-sale prices.

It sounds like a pretty risky time to buy. Is bargain hunting a good idea?

You need to be very brave, but there’s no doubt some great companies – banks and big miners particularly – look quite cheap from a historical perspective.

If you are interested in scooping up some cheap shares, our wealth and super guru Michael Laurence recommends the tactic of dollar-cost-averaging, which involves investing an amount of capital into the market at regular intervals to reduce, at this time, the risks of being caught by a sudden downturn in prices.

When do you think we’ll see the markets start to turn around for the better?

The world is really looking for a lead from the United States, the true home of this whole crisis. As CommSec’s Craig James says: “The simple message is that the US authorities must finally get their act into gear. This is a US-driven crisis and demands a US-driven solution to problems in financial and auto sectors.”

The markets are really hoping for some decisive action from US regulators. US Treasury Secretary Henry Paulson’s backflip on the Government’s plan to buy mortgage debt hasn’t exactly filled the world with confidence.

In fact, the market is really waiting for a lead from Obama, who says he is working feverishly on plans to lift the US economy out of its current state. Obama has promised change – let’s hope he can fulfill that promise and turn the US situation around.