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Accounting for Wall Street’s week of carnage

Weak labour data sent a signal to investors that US share markets might be overvalued. AAP

Share markets in the US and around the world are expected to fall again this week following sharp declines on Wall Street last week.

The Dow Jones industrial average closed on Friday down 2.3% for the week.

Australian shares started this week lower, trading down 0.48% at noon on Monday.

Last week’s falls came on the back of a raft of negative economic data, including sluggish monthly jobs-growth figures, prompting analysts to warn of a slowdown in the US economic recovery.

Is lingering high unemployment in the main factor behind last week’s falls on Wall Street?

Yes. I think it’s pretty difficult for the market to get information about market-wide effects. These official releases are important and they have been for a very long time.

I’m not surprised that the market is reacting strongly to this bad news. The market tends to react in an asymmetric fashion.

It tends to react much more strongly to bad news than it does to good news. So you often see very large downward movements when information is worse than expected.

To my mind, this is not surprising. We’re seeing quite long series of negative data releases.

This may suggest that perhaps the equity market has been over-valued.

Last week was particularly bad, but US markets are mostly higher for the year. Do these recent falls point to short-term volatility, or do you see them continuing into the longer term?

We’ve seen about five weeks of continuous falls, which is perhaps the most consistent series of falls on the US market since 2004.

I suspect that the period is unusual, but should we expect another cataclysmic crash? I don’t have a sense of that.

I believe that the US economy is growing, but not as fast as people hoped it would be growing. That’s leading people to reassess their views of the market.

How useful is employment data as an indicator of the progress of the US economic recovery?

Traditionally it has been important because employment data shows us how many people are being paid, how many people are able to buy things and to some extent, it tells us about how much people are consuming.

These factors are very important in the US economy, where a lot of the growth is driven by the population buying things.

The US is an exporter, but the main driven of the economy is its internal consumption.

The US unemployment rate has been lingering around 9% for some time now. Are you optimistic about a rebound in employment in the coming months?

That’s the key thing that people are worrying about. Unemployment is high, and it appears to be stuck there.

Many people thought the increasing growth rate – which is of course coming of a low base – would lead to lower unemployment.

That simply isn’t happening.

There is a serious question around how quickly the US economy can turn itself around.

In the 1930s, it took the US along time to get itself out of the doldrums that followed the Great Depression.

I suspect that the global financial crisis has created a similar situation.

There are similarities between the two eras.

In the Great Depression the banking sector took a massive hit, and the same has occurred during the most recent crisis.

It just takes some time for the structural problems that lead to the crisis to be sorted out.

There have been large amounts of money spent on trying to maintain the economy as it is, but a number of commentators have the suggested that perhaps the US economy needs to see more structural change.

This takes time and it is very painful, and the US seems to be finding out now that pouring more money into the economy to prop up the existing structure isn’t really working.

They may need to let the economy find its own way.

The local share market has started the week lower, but hasn’t fallen as sharply as anticipated. Given the strength of Australian economy, do you think the local market is to some extent ignoring leads from Wall Street?

Australia’s economy is less tightly linked with the US than in the past. We are much more closely linked with China and India, mainly because of the resources boom.

Without the resources we would be going through a terrible time.

But inevitably, the major financial markets will have an impact on Australia.

The US, UK and European markets reflect world economic values as much as their own economies’ values.

So there will be always be some feedback into Australia.

We will never be able to say that we’re cut adrift. We have major companies like BHP Billiton listed in the US and Australia, so people are going to be trading on BHP shares in the US well before they start trading here.

So value movements in the US are inevitably going to feed into the Australian market.

The Australian Financial Review reports that Australian superannuation funds have managed to their balances to pre-financial crisis levels. Are super funds at risk of losing this ground again, or have they sufficiently diversified their assets in the wake of the crisis?

The problem for the super funds is that they are very well diversified, so if the world market collapses they can’t avoid it.

If they were just holding government bonds then they’d be protected for as long as the government remains in place.

But when they move into more risky securities like shares then you face having an investment in companies that are globally integrated and are subject to global economic movements.

Super funds can diversify across asset classes, but as we saw during the global financial crisis, the two asset classes that worked together in a helpful way during the 1987 crash – property and equities – both collapsed in the global financial crisis.

I don’t think we can really expect super funds to avoid volatility. Their wealth creation is achieved to some extent at the expense of taking on greater risk.

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