Business

Share market plunge is in danger of becoming self-fulfilling

Feedback loops played a central part in Nobel-prize winning economist Robert Shiller's book Irrational Exuberance, which predicted the end of the '90s sharemarket internet boom and set out a template for the booms and busts that followed.

Market prices rose for good and bad reasons to create the "skin" of a market bubble, he wrote. Feedback loops then operated in the manner of a Ponzi scheme to inflate the bubble, as investors waded in after hearing about others who bought successfully before them.

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Bank shares plunge in $40b ASX wipeout

Shares in the big four Australian lenders drop 4 per cent or more, leading a $40 billion sharemarket wipeout on Tuesday.

Similar trends are working in reverse this year as the global market selloff gathers pace, with the big banks now being battered by genuine negative feedback loops, and "me-too" selling that was an example of "heard mentality", based on reports, speculation and other things people had "heard".

Credit spreads on energy debt jumped in January as the oil price continued to fall, which was reasonable. That has morphed this week however into general market paranoia, and whispers about the exposure of banks in the energy sector and beyond, as lenders, lenders to lenders, and owners of corporate paper and derivatives.

It all has a 2008 global crisis feel about it, without the underlying causes. Shares in the big four local banks fell by a surreal 4 per cent to 5.2 per cent on Tuesday. Ahead of that, bank shares plunged overseas, with Deutsche Bank leading the way down. Its shares have fallen by almost 39 per cent this year to less than 40 per cent of its balance sheet book value. They fell 8 per cent on Monday, forcing the group to reassure investors that it could still service its debts.

It's certainly not all baseless fear. Share sales by sovereign wealth funds retreating to cash and big sales of foreign reserves by China and oil-producing countries who are being financially stressed by the oil price plunge are also generating unquantified but undoubtedly large and destabilising financial flows, for one thing.

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China's foreign exchange reserves fell by just under $US100 billion to $US3.23 trillion in January after falling $US108 billion in December as Beijing propped up the value of its currency.

Our Reserve Bank also estimated in its statement on monetary policy last Friday that Saudi Arabia's foreign Reserves fell by $US115 billion to $US604 billion last year. JP Morgan estimates that oil-producing countries and their sovereign funds will need to sell assets including shares and bonds worth $US240 billion this year to fund budgets shortfalls caused by the oil price slump.

Still, it's beginning to look overdone, for the banks in this market at least. Our big four banks are caught up in the selloff, but they are less exposed than Tuesday's share price plunge suggests.

Their focus on home lending sees them derided as glorified building societies when markets are rising, but it is an an asset in times like this when the focus is on corporate and derivative market exposure. Their dividends and dividend yields will still beat fixed interest alternatives here even if they trim their payouts to shareholders to help them meet tougher capital backing rules. CBA gets to chance to set the pace when it announces its interim result and dividend on Wednesday.

As to which feedback loops are real and which ones are examples of "herd mentality," in a market like this, it probably doesn't matter.

Global share markets have fallen further this year than commodity prices with the exception of the oil and gas sector. They are falling in the absence of clear signs that economic growth is collapsing in the US and Europe, and despite signs that it is stabilising in China.

Some of the concerns in the market are real. In the crucial US share market, commodities, currencies and China also have a bigger weight on on the revenue of big listed US groups than they do in the US economy at large, for example.

Rupert Murdoch's 21st Century Fox group served up an example on Tuesday. It told investors that earnings in the December half were held back by a $US220 million foreign exchange hit as a rising US dollar depressed earnings from outside the United States that the group books in its home currency.

The group's chief financial officer John Nallen said the currency impact was twice as big as 21st Century Fox expected when the half year began, and could grow to $US350 million by year-end.

It's getting close to double jeopardy now, however. The world is not as sick as the global bank share rout suggests – but if the selloff continues, it could be.

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