Finance Finance News The stock market correction we had to have
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The stock market correction we had to have

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The shocking, sudden re-rating of global equity markets has come just at the right time to distract attention from the guff Treasurer Joe Hockey has been talking on income tax cuts.

That’s appropriate, as Mr Hockey’s attempt to turn bracket creep into an economic bogeyman is, firstly, of little consequence and, secondly, a problem that is easily solved.

Raising bracket creep at a time of record low wages growth is almost insulting to the lower-income workers who would normally be hit disproportionately as inflation pushed their wages into higher tax brackets.

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More importantly, either side of politics could end the cycle of politically-motivated income tax cuts simply by indexing tax thresholds to inflation – as several OECD nations have already done.

So let’s flush the bracket creep furphy down the nearest toilet and look at the bigger story – the plunge in our stock market and what that means for Australia’s medium-term prospects.

The current stock market turbulence is very serious for certain classes of investors such as those who have borrowed to invest, those who have put too much of their investment portfolio into shares in the first place, and for retirees who have believed some of the more optimistic forecasts for their share portfolios.

Investors are waiting to see how much money they will get back out of BBY.
Certain classes of investors are more exposed to the stock market correction.

Remember the breathless commentaries in March and April about nearly breaking through the 6000-mark on the ASX 200 index? Anyone who thought that was a good thing was labouring under some severe delusions.

Share prices that increase ahead of company profits are only a good thing if (a) you own those shares before they are over-valued and (b) you manage to sell them before the kind of correction we are currently seeing.

But some people who were caught up in the ‘6000!’ hype will now face the prospect of having bought over-valued assets, and will therefore suffer capital losses.

In more normal times, the 17 per cent fall we saw on the ASX through to Monday could be dismissed as cyclical. The prudent thing in that case would be to wait for share prices to rise again before selling some to rebalance one’s portfolio.

However, we are not in normal times. As I wrote three weeks ago, a major re-rating of Australian assets was on the cards anyway.

To recap: “There may be large corrections in the share market and housing market when the Federal Reserve tightens rates and draws investment dollars back to the US. That’s not guaranteed, but the Fed rate hike will be a game changer, with unpredictable consequences for a small economy such as Australia.”

What has changed?

Well we’ve had a few surprises from China that in many ways have brought forward the capital-flow chaos that was expected from the much-telegraphed Fed rate hike.

China
Surprises moves in China have weighed on the Australian market. Photo: Shutterstock

Softer-than-hoped-for economic data from China, plus the deflation of that nation’s property and stock market bubbles, were not entirely unexpected, but have nonetheless weighed heavily on emerging markets and commodity exporters.

The real bombshell was China’s out-of-the-blue currency devaluations on August 11 and 12.

While only representing a three per cent fall against the US dollar, China’s decision to alter its long-standing currency-pegging mechanism and let market forces have more impact on the renminbi, had a large ripple effect through commodity-exporting markets and their currencies.

Those ripples, in effect, have not stopped. Indeed they have amplified in the intervening trading days culminating in big sell-offs on most global stock exchanges on Friday and Monday (on Tuesday, the ASX 200 index closed up 2.7 per cent).

Global investors have known for a long time that a move towards normalisation of the Fed’s monetary policy would cause large capital flows. For that reason, a lot of traders have had their finger on the ‘sell’ trigger.

China’s unexpected currency moves, plus heightened fears over the future of its growth story, have clearly seen many traders pull that trigger prematurely. That kind of selling picks up its own momentum.

Where does that leave Australia?

Actually, while the news may be terrible for some investors, for the economy overall it’s not too bad.

The Australian dollar was always headed lower than the current 71.5 US cents.

Australian equities, too, were always going to get a re-rating in the months ahead – probably followed by a correction in the property market a few months later.

In some ways, China has done us a favour by making the Fed shock a two-step process. All investors will now be reconsidering their investment strategies and viewing the share market spruikers with more suspicion.

Two mining operations in Tasmania's north-west have already been shelved in the short term.
Australians will soon discover the real value of their assets.

Of course, many are now asking whether the Fed will raise rates at all before year’s end, given the hit to confidence caused by the global shares rout.

Well there’s no way to tell, but it is in Australia’s interest to get that event behind us – share price and dollar falls not withstanding.

For six years the global financial system has been in an unnatural hiatus, with extraordinary monetary stimulus helping a little to boost real economic growth, but doing a lot more to boost asset inflation.

And asset inflation is not real economic growth.

The best thing for Australia’s future would be to discover, sooner rather than later, what our assets are really worth and where that leaves us on the global wealth scale.

Only then will important economic reforms make sense to the voting public. Only then will we start taking our productivity and global competitiveness seriously.

To get back to hot-air Hockey for a minute, even his tinkering with tax brackets will make more sense when we know what kind of sustainable wages growth (or decline) to expect in the years ahead.

And we won’t know that until the selling is done.

Read more columns by Rob Burgess here

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