Wall St is up 452 points in two days and we are trying to respond but struggling. After a 79 point rise early on the market is now flagging in low volume to be up 33 - Not as promising as the 92 point rise the SFE Futures. Resources outperforming +2.1% led by the big boys – BHP, RIO and FMG up 2.5%, 2.2% and 3.8%. The drop in the market from the open this morning has come in financials – they were up 1.6% and are now down 0.6%. The NAB has announced a new CEO following last week’s profit warning. They were up 2.1% first thing and are now down 1.3%. Stocks hitting fresh yearly lows today include TABCORP Holdings and Patties Foods.

Wall Street closed up 186. Up 189 at best. Up all session – closed on high. It was a good night for Financials +2%, diversified banks up 3.8% and Investment banks and brokerages +3.5%. Bush signed the Housing Bill that will save 15% of flailing home-owners – designed to reduce foreclosures. Fannie Mae and Freddie Macquarie Group up 5.3% and 3.7% after the Securities and Exchange Commission (SEC) extended the emergency limit on naked shorting until August 12^th. Oil had a good night – up 3.7% - which led to oil sensitive stocks falling - Automobiles down 3.8% and the Amex Airline Index down 4.9%. 2Q earnings on the S&P have dropped 24% verses a year earlier says Bloomberg – Ex financials earnings have gained 2.8% so far. Companies missing 2Q estimates: Garmin down 22%, Cisco down 1.12%, and Electronic Arts down 6.56% offset strength in Comcast which was up 4.64% despite posting below-expectation-results. The NASDAQ had an OK session closing up 0.44%.

• Both BHP and RIO up in ADR form overnight, 2.7% and 4.16% respectively.
• Metals mostly up overnight – Copper up 1.23%, Nickel up 3.9% and Zinc down 0.32%. Aluminium was unchanged.
• Oil price up $4.53 to $126.74 after a surprise 3.5m barrel fall in U.S. inventories.
• Gold down $13.60 to $902.90
• Bonds down with the 10 year yield up to 4.05% from 4.04%.

The big news this morning is that Brisconnections unit trusts (BCSCA) have listed today at a dollar and have traded at 48c. This is the company described by its own CEO as a natural short. That should put a few planned floats on the back burner for a month or twelve.

The other big news today is the National Australia Bank (NAB) announcing Cameron Clyne as John Stewarts replacement. Clyne currently heads the NAB’s New Zealand operations and will take over from Stewart on Jan 1 2009, but will become group CEO designate on October 1 to “ensure an orderly handover”. The fact that the appointment was internal suggests that either the NAB management has depth or it has a lack of options. Coming so close after the profit warning the market would be excused for a wry smile on the NAB statement that “Mr. Clynes appointment represented the culmination of an extensive succession planning exercise conducted over the last 18 months”. Nothing to do with the profit warning then. NAB was up but is now down 38c to 2509c.

Double Whammy for Woolworths: New Zealand’s Court of Appeal overturned a High Court ruling that would have allowed Woolworths and Foodstuff to make a takeover bid for The Warehouse Group in NZ. On another issue, the AFR reports that the ACCC is set to propose several major reforms from its grocery price inquiry, which will include a Grocery Watch price monitoring system. WOW down 9c to 2495c.

• ABC Learning has released a Trading Update: Expects FY08 Loss before tax $437m due to additional write-downs and provisions and it won’t pay a 2H dividend. Says it is compliant with all banking covenants and that the first three weeks of FY09 have been encouraging. ABS down 11% to 73c.
• Goldman Sachs and Southern Cross Securities sell 30m shares in Fortescue at 800c ($240m). 4.8% discount – on behalf of an early backer (KC Wong?) – offered to International institutions. KC Wong has 134m shares. He bought at prices of between 1 and 3c. Harbinger also thought to be a seller of 17.5% but more likely to do it to a buyer than to the market. Hasn’t done the share price any harm this morning. FMG up 47c to 887c.
• Alumina (AWC) interims are out – look good - 1H Net profit of $43.8m with underlying earnings off $152m, in line with 2H07. Declared an interim dividend of 12c and expects global demand to remain strong. AWC up 12c to 449c.
• Leighton Holdings (LEI) announced its John Holland division has been appointed construction partner for the $240m contract to strengthen the West Gate Bridge. LEI up 11c to 4236c.
• Just Group (JST) up slightly after saying it expects to announce a 3.5% rise in 2H sales with FY08 sales above the mid point of its guidance. JST up 9c to 326c.
• Asciano (AIO) flying – up over 10% - on speculation it may have cancelled plans for dilutive rights issue of over $1bn and be about to embark on asset sales instead. AIO up 49c to 415c.
• Australian Worldwide Exploration (AWE) has released their June Q report. June Q revenue of $254m, resulting in record FY revenues of $821m. AWE has net cash reserves of $339m, is debt free and is looking for growth opportunities. AWE up 5c to 359c.
• St. George Bank’s (SGB) board has re-endorsed its recommendation for the Westpac takeover offer during a two-day meeting that ended yesterday afternoon. SGB up 29c to 2700c and WBC up 19c to 2113c.
• Macquarie Infrastructure Group (MIG) up on the news that Macquarie has put it on their restricted list (can’t publish research recommendation or advise on it) prompting the rumour that it is one Macquarie satellite that will be privatised. MIG up 4c to 265c.
• Perilya (PEM) announced production numbers – June Q Broker Hill lead output 13,368 tons and Zinc output 28,344 tons. Metal output up 18.5% on the Q. PEM up 1c to 54c.
• Arrow Energy (AOE) have increased their net 2P reserves by 81%. AOE up 6c to 329c.
• ROC Oil (OSH) has released their Bidder’s Statement for Anzon Australia.  ROC down 0.5c to 149.5c.
• ConnectEast Group (CEU) announces EastLink average daily trips of 270,868 in the first 25 days.  CEU down 0.5c to 94c/
• ANZ CEO Mike Smith has told The Australian that the market has had “a correction that was needed” (don’t you hate that hindsight cliché) and investors had “lost sight of the fact that banks are still very profitable businesses” in this country. ANZ up 19c to 1629c.

Thanks to the US sub-prime crisis, the oil shock and higher local interest rates Australian shares look like having their worst financial year since 1981-82.

While Australian resources shares have boomed on surging commodity prices, most of the rest of the market slumped on debt concerns and profit worries.

The AMP’s chief strategist, Dr Shane Oliver says shares are oversold and due for a short term bounce, but the next 3 or 4 months are likely to remain rough.

We believe we can expect a strong rebound in the December quarter and better conditions over the next 6-12 months.

“Shares are good value and will perform better as the bad news abates.”

Australian shares worst financial year since 1981-82

Short of a surge in the next few days, the Australian share market is on track for its worst financial year since 1981-82.

For the financial year to date the Australian share market is down 14%, against a 32.4% fall in 1981-82 which occurred as the economy slid into its worst post WW2 recession.

Global shares as measured by MSCI are also down 15% in local currency terms (but more in $A terms).

The slump in shares has driven sharp declines in superannuation returns, possibly to their worst financial year since 1987-88 or possibly even the last 25 years.

The big question is whether we will see an improvement over the next year or will shares simply continue to slide.

A “perfect storm”

A year ago, most investment commentators thought that share and superannuation returns would slow after four very strong financial years.

But, apart from the perennial bears, no one foresaw anything like the slump we have seen over the last year. The last year can be likened to a perfect storm for shares and other investments:

• The sub-prime US mortgage crisis led to a credit crunch which led to a collapse in financial shares & companies heavily exposed to debt, and a slowdown in growth;

• The near doubling in oil prices and a sharp spike in food prices pushed inflation and inflation expectations greater pressure; and, more recently,

• Hawkish central bank rhetoric around the world (such as the US Fed now paying more attention to inflation) has removed a leg of support for shares.

This has seen shares fall as investors lost confidence in the outlook, but also as credit dried up and its cost rose.

While Australia has benefited from the surge in commodity prices on ongoing strength in the emerging world the benefit has been largely offset by much higher interest rates as the Reserve Bank has sought to stop a pick-up in underlying inflation.

This is evident in the huge divergence between Australian resources shares (which are up 25% over the last 12 years) and financials and consumer discretionary stocks (which are down 32% and 41% respectively).

Share market volatility has surged as investors were hit by wave after wave of bad news and struggled to determine the outlook.

Over the last year there have been 108 days where Australian shares rose or fell by 1% or more, which is well above the average of 43 days over rolling 1 year periods over the last 18 years. See the next chart.

Reasons to be cautious over the next 3 or 4 months

After big falls since mid-May shares are very oversold and due for a bounce.

The slump in Australian shares has been made worse by tax loss selling into the end of the financial year - when this lifts it will lead to a decent bounce.

However, beyond the potential for a bounce over the next few weeks there are several reasons for caution over the next 3 or 4 months with further share market falls likely:

• we have yet to see the full economic fall out from the US housing slump and credit crunch;

• oil prices remain at a level which is threatening the global and Australian growth outlook;

in Australia we have yet to see the full economic impact from the rise in interest rates and higher petrol prices;

• given the uncertain economic outlook we are likely to see more earnings downgrades in the next few months;

• the current inflation scare globally and the back-up in bond yields and tougher central bank rhetoric is a headwind for shares in the short term; and

• The May to October period is often difficult for shares & US presidential election uncertainty may not help either.

Expect stronger conditions into year end

However, while the next few months are likely to remain rough it’s probable that shares can remain above their March lows and shares are likely to rally solidly into year end and into 2009.

Firstly, unlike prior to the deep and long bear markets in global shares in 1973-74 and 2000-03, shares were not, and are not now, overvalued this time around.

In fact after recent falls they are now cheap. Global and Australian shares are now trading on lower forward PE ratios than was the case at the end of the last bear market in March 2003. Australian shares are trading on 12 times which is their lowest since 1995 and compares to a ten year average of 15.2 times.

Global shares are trading on a forward price to earnings multiple of 12.2 times compared to a ten year average of 17.4 times.

As a result, the Australian share market is trading below the bottom end of its fair value range. See the next chart.

The Australian share market normally moves with profits.

However, as evident in the previous chart, the slump has taken shares way below the level suggested by profits.

The shares over six years to make new highs because that’s how long it took profits to rise to justify the 1987 high.

Secondly, right now it is unlikely there will be a sufficient profit slump to justify the current level of share prices.

Thanks to economic stimulus, low inventory levels, a lack of corporate overinvestment and a strong contribution to growth from exports the US economic slump is unlikely to be deep and should be over by year end.

While growth in the rest of the world (including Australia) will slow it’s unlikely to collapse. Growth in the emerging world is slowing, but is still likely to remain very solid providing an important buffer to the slowdown in the developed world.

In Australia’s case, industrial shares are vulnerable to downgrades but resources earnings are being upgraded given the huge rise in iron ore, coal and other commodity prices.

Resources sector profits should rise by 60-70% in 2008-09 and should ensure that the profit line in the previous chart keeps rising.

Thirdly, low interest rates in the US are providing a significant boost to global liquidity and some of this will find its way into shares. With US growth likely to remain low and inflation expected to fall it’s hard to see the Fed raising interest rates any time soon.

Fifthly, if credit markets continue to improve that should also be positive for shares. It’s noteworthy that the latest slump in shares has not seen the sort of deterioration in credit market indicators that occurred in August, January and March, which provides some confirmation that credit conditions are gradually improving.

Finally, the rise in the oil price has recently become very speculative and a fall back towards $US100 a barrel is likely sometime in the next six months. If so, this would be very positive for shares.

Putting recent falls in context

It’s worth bearing in mind that Australian shares have had numerous setbacks over the last 108 years. In the midst of many of these it seemed like the “worst ever” crisis, but the market has always recovered to resume its rising trend.

Concluding comments

The last year has not been kind to investors. History tells us that bear markets come along every few years, but that after a bad patch the market resumes its rising trend.

While the next few months are likely to remain rough, shares should gain into year end as investors start to look towards better conditions in 2009 at a time when shares are cheap.

The key risks are a collapse in the US or China, a further oil price surge or a slump in Australian consumer spending