Jerry Parwada

There has been a mass of negative information over the past few days, and investors can’t just ignore it.

Even though Australian shares have staged a strong rally, it follows Wall Street’s sixth biggest points drop on record. Investors have dumped riskier assets on fears the US is headed back into recession and after the US was stripped of its triple-A credit rating.

Market players are looking for any signs as to the conditions they are going to face in the markets in the short term, and maybe the medium term as well. Uncertainty is stalking the market, even though there isn’t a logical reason for the markets to melt down, as the US debt downgrade had been widely anticipated. However there is a lot of uncertainty about what is going to happen in Europe, and although there are reports that the European Central Bank bought Italian and Spanish government bonds yesterday to try and stem the crisis, there is real fear. While Italy is too big to fail, it is also too big to bail out, and unless there is more belt tightening in Europe, we could see defaults there.

Overnight the Moody’s ratings agency has presented a more hopeful perspective than S&P on last week’s debt-reduction deal, which will cut more than US$2 trillion (S$2.44 trillion) from US government spending over the next decade. Moody’s says that the United States remains on a fiscal footing that is as solid as other AAA-rated countries.

The US debt downgrade will have little practical impact as the US remains the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven. A rating is a measure of probability of a lender getting their money back. In this case it is an estimate that a government is going to ignore its borrowings, but there is little question of that with the US. People will still lend to the US. China will continue to buy US debts. The markets have tanked, but it is just a knee-jerk reaction to the need for information. And all the information is negative, so it has a negative effect on market sentiment.

The Australian dollar has dipped below parity, losing nearly 10 per cent against the US greenback in just two weeks. Meanwhile Chinese data shows consumer prices rose at the fastest pace in more than three years, stoking concern China will not be able to respond to weak global growth by dropping interest rates.

With all this going on, it might mean that a country such as Australia will not be immune to this unfolding crisis after all, particularly in markets for liquid assets such as equities.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.