History Tells The Story

Sun Herald

Sunday August 17, 2008

David Koch

Forget the fluctuations - in the end, the historical average usually prevails.

THE past few weeks have been full of surprises for financial markets and investors. The strong Australian dollar has reversed its momentum, oil has tumbled from its record peaks, bank shares have bounced back and all of a sudden a cut in official interest rates is looming rather than forecast for next year.

Each of these events has been analysed in detail on why they occurred so suddenly and against all expectations. The dollar was headed for parity with the greenback, oil was supposedly set to break $US200 ($230) a barrel, bank shares were expected to be hammered further by the credit crunch and slowing economy, while official interest rates were likely to remain steady.

What happened?

Could it have simply been history - in other words, a return to historical averages? I sometimes wonder if by focusing so much on the day-to-day detail of markets and the latest news that we forget to step back and look at history. We forget to benchmark markets against historical averages and understand that history tells us that markets tend to gravitate to those long-term averages.

A pendulum is a good analogy. Markets swing like a pendulum and can overshoot on both the upside and the downside.

Understanding historic averages can provide a useful insight into whether a market is over- or underheated. Then it's a matter of timing the correction to take advantage. Mind you, getting that timing right can be incredibly difficult.

Throughout history, various indications can point to a correction back to the historical norm.

* The Aussie dollar was forecast to hit parity with the greenback before Christmas but then the US dollar bounced back off its record lows, the local economy slowed and the prospect of imminent interest rate cuts sent it tumbling.

* An unexpectedly sudden batch of sluggish retail, housing, consumer and business confidence caught many economists by surprise and had them adjusting their previously robust economic forecasts to something a lot softer. Then the Reserve Bank indicated it was happy to live with higher than acceptable inflation for the time being and would focus on maintaining a solid economy. In other words, the RBA is happy to cut interest rates to stimulate the economy sooner rather than later. It has plenty of room to move, considering it lifted rates early and quickly compared with the rest of the world.

* Bank shares were slammed by investors because of fears the rising cost of money and write-offs from exposure to the credit crunch, along with the profit impact of customers feeling the pinch of the economic slowdown. Yet with the Big Four bank shares dropping to levels that produced dividend yields of about 10 per cent, they proved irresistible bargains for investors. As well, the banks started proving they were maintaining profit and dividend levels in these tough times by gouging more out of customers.

As I said last week, while the banks were quick to lift loan rates above that of the rise in official rates to offset the rising cost of money from the credit crunch, they've been slow to reduce rates independently of the Reserve Bank when the cost of money has eased on money markets.

Banks often wonder why they have such a bad, greedy reputation with the public - well, they only need to look at their current actions to see why.

* Fears of an imbalance between global demand and supply of oil pushed the black gold to record levels, which came with forecasts from the OPEC president that it could breach $US200 a barrel. Then the same demand and supply kicked in as prices rose. Demand realigned as economies started to slow and businesses and consumers cut their usage. Even this week's trouble in Georgia wasn't enough to spook a jump in prices despite Europe's most important oil pipeline running through the country. What a difference a few weeks make.

Yes, there are plenty of instances where some investments have set new long-term levels, but it is interesting how major markets gravitate to their historic average.

© 2008 Sun Herald

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