Is the Australian share market efficient?
Australia has a wealthy, Western-style mixed economy, with a per capita GDP, in terms of purchasing power parity, vaguely higher than those of the UK, Germany, and France. The country was ranked sixth in The Economist worldwide quality-of-life index 2005 and third in the United Nations’ 2006 Human Development Index. The absence of an export-oriented manufacturing industry has been considered a key weakness of the Australian economy.
More recently, rising prices for Australia’s commodity exports and increasing tourism have made this criticism less significant. However, Australia has the world’s fourth largest current account deficit in absolute terms, in comparative terms it is more than 7% of GDP. This is considered challenging by some economists, particularly as it has concurred with the high terms of trade and low interest rates that make the cost of servicing the foreign debt low. (Colebach, 2005)
The market structure of Australia shows a radical change in the structure of the Australian market over the last ten years. At the end of June 1992, the domestic market capitalization was $198 billion. By the end of June 2002, the market capitalization had increased to $700 billion. For that reason, while the Finance & Insurance and the Other Services sectors
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In determining the market attractiveness and efficiency, the key measure to use is the liquidity. It computes, in percentage terms, the volume of trading in relation to the size of the market. Investors look upon liquidity as one of the most important elements of a market, since in a liquid market, securities can be bought and sold more easily so the general cost of trading activity, and consequently risk for the investor has decreased.
Over the past decade, Australia has experienced an upward turn over. There are two other significant aspects which, joined with liquidity, define the attractiveness of a market to investors. These are efficient price discovery and the depth of the market. The depth of the market can be seen by the capitalizations of the market, the depth of the Australian market has grown drastically over the past decade. (https://www.cia.gov, 2008)
The basis of determining a country’s market efficiency is through the efficient market hypothesis (EMH) which implies that if new information is revealed about a firm it will be combined into the share price quickly and logically, with deference to the bearing of the share price movement and the size of that movement.
In an efficient market no trader will be introduced with an opportunity for making a return on a share other security that is greater than a fair return for the risk related with that. The deficiency of abnormal profit possibilities occurs because current and past information is instantly reflected in current prices. What causes prices to change is new information. Perfect powers of prediction of investors is not denoted by stock market efficiency all it implies is that the current level is an unbiased estimate of its true economic value basis on the discovery of new information. (http://www.asx.com.au, 2008)
Prices are set by forces of supply and demand in the major stock markets of the world. There are hundreds of analysts and thousands of traders, each receiving some new information on a company through electronic and paper media. The instant an unforeseen, positive piece of information seeps out investors will act and prices will rise quickly to a level that gives no chance to make additional profit. (http://cbdd.wsu.edu. 2008)
Different levels of efficiency according to the type of information, which is reflected in prices, were identified by economists. Three levels of market efficiency can be identified as weak-form efficiency, semi-strong form efficiency and strong form efficiency.
The first form is the weak-form efficiency is where share prices fully mirror all information contained in past price movements. Seeing that the future cannot be forecast in such way, it is useless basing trading rules on share price history. For instance technical analysts utilize a vast variety of trading rules. Others recommend a purchase when a share rises in price at the same time as an increase in trading volume takes place. Some suggest buying shares that have carried out well in relation to the rest of the market, retaining that their performance will continue in that vein. Tremendously the evidence and weight of academic opinion is that the weak form of the EMH is to be honored. The history of share prices is useless to foresee the future in any peculiar profitable way.
The second form is the semi-strong form efficiency where share prices fully mirror all the significant publicly accessible information. This comprises not only past price movements but also earnings and, technological breakthroughs, rights issues, dividend announcements, resignations of directors, and others. The semi-strong form of efficiency means that there is no advantage in studying publicly available information after it has been given out, for the reason that the market has already engaged it into the price.
As an example, the semi-strong form tests focus on the matter of whether it is worth acquiring expensively and analyzing publicly available information. If semi-strong efficiency is true it dents the work of millions of primary professional or amateur analysts whose trading rules cannot be useful to fabricate abnormal returns as all publicly available information is already mirrored in the share price.
The third form is the strong-form efficiency where all relevant information, together with that which is confidentially held, is mirrored in the share price. In this form the focal point is on insider trading, wherein a few privileged individuals, directors per se are capable to trade in shares, as they more aware compared to the normal investor in the market. In a strong-form efficient market even insiders are powerless to make abnormal profits even if the market is acknowledged as being ineffective at this level of definition. For instance, it is well known that it is feasible to trade shares on the basis of information not in the public domain and in this manner make abnormal profits.
In this light, stock markets are not strong form efficient. Trading on inside knowledge is perceived to be a “bad thing”. It makes those outside of the captivated circle feel cheated. A breakdown of the fair game perception will give investors the feeling that the inside traders are making profits at their expense. If they start to believe that the market is less than a fair game they will be more hesitant to invest and society will suffer.
To prevent the loss of confidence in the market most stock exchanges try to control insider dealing and it is a criminal offence for most exchanges. Insider trading is measured to be, aside from dealing for oneself, either procuring another individual to deal in the securities or communicating knowledge to any other person counseling, while being conscious that they will deal in under those securities.
The efficient market hypothesis has several implications for the investors and the companies. For the investors, the vast majority of people public information cannot be used to gross abnormal returns in which returns above the normal level for that systematic risk class. The implication is that basic analysis is a wasting of money and that as long as efficiency is preserved the average investor should basically select a correctly diversified-portfolio, in so doing circumventing the analysis and transaction costs.
Investors need to press for a larger volume of appropriate information. Semi-strong efficiency relies on the quality and quantity of publicly available information, and so companies should be confident by investor pressure, government rulings, accounting bodies and stock market regulation to offer as much as is attuned with the need for some concealment to avert competitors discovering useful knowledge. The discernment of a fair game market could be enhanced by further deterrents and constraints placed on insider dealers.
For companies, a number of implications are subject on a company in the efficiency market hypothesis. Substance is the focus, not the short-term appearance, for some managers behave as is they believe they can deceive shareholders. For instance creative accounting is utilized to show a more remarkable performance than what is just necessary. More often than not, these tricks are obvious to investors, who are able to construe the real position, and security prices do not ascend synthetically.
In circumstances in which the drive for short-term heightens reported earnings could be positively harmful to shareholders for example, a firm might have a tendency to overestimate its stock to advance short-term profitability; one more might not record bad debts. These doings will result in further, or at least advance, taxation payments, which will be risky to shareholder wealth. Managers being aware that the analysts regularly pay a great deal of attention to accounting rate of return, when facing an option among a project with a higher NPV but a poor short-term ARR, or one with a lower NPV but higher short-term ARR and will opt for the latter.
It is not that essential for the timing security issues to be fine-tuned. Regard a team of managers weighing up a share issue who sense that their shares are presently under-priced because the market is low. They will decide on to delay the sale, hopeful that the market will rise to a more “normal level”. This flouts the logic of the EMH wherein if the market is efficient the shares are already acceptably priced and it is just as similar that the next movement of prices will be down as up. The past price movements have nothing to do in relation to future movements.
The situation is somewhat differs if the managers have confidential information that they what they are aware of are not yet priced into the shares. In such scenario if the directors have good news then they would be shrewd to wait in anticipation of after an announcement and consequent adjustment to the share price before putting to market the new shares. Appalling news announcements are more complicated, to sell the shares to new investors while keeping bad news may benefit existing shareholders, however will result to loss for the coming in of new shareholders. (http://cbdd.wsu.edu, 2008)
The Australian economy, over the recent years has outpaced larger developed economies and has proved flexible despite of global and regional economic downturns. The Australian economy has grown speaking of real terms by an average of 3.7 per cent annually over the past 10 years. This compares to an average rate of growth of 2.25 per cent across the G7 economies.
Australia keeps on changing into a dynamic, open economy completely incorporated into both global and Asia-Pacific trade. In a span of 20 years, Australian trade in goods and services has increased by an average of 7.9 per cent per annually. Encompassing strong comparative advantages predominantly in the mining and agricultural sectors for over a century, Australia is on the rise of new competitive strengths as an international supplier of services and advanced goods. Australia is in general a price taker in international markets, on average accounting for around one per cent of global the trade.
By tradition, Australia has been a capital importing country and has consequently operated with deficits in its current account. The current account deficit widened in the past to years to an average of 6.3 per cent of GDP compared to a ratio of 5.9 per cent in 2004. In total, the deficit on the current account increased to $55.3 billion in 2005, which is 1.2 per cent higher than the deficit recorded in 2004. Over the past years the aggregate current account deficit has more than trebled. This is because to an increase in the net income deficit where the net of income flows into Australia.
The aggregate deficit in Australia’s income balance increased to a record high $35.2 billion in, an increase of 23 per cent on the previous year. The increasing deficit over this period mirrors Australia’s large interest rate discrepancy with other major economies, particularly the United States and EU as well as the tough performance of the Australian share market in relation to other world bourses. It also shows the high level of foreign borrowing in Australia. In 2005, the ratio of net foreign debt to GDP averaged a record high of 49.7 per cent. In comparison, the aggregate deficit in Australia’s balance on goods and services or the net of exports and imports, fell to $19.6 billion in 2005 after a record deficit of $25.7 billion was reached in 2004.
The balance on goods and services has improved noticeably because of higher merchandise exports, which increased by 18 per cent in 2005 on the support of high world article of trade prices as well as a stabling in the Australian dollar. On the other hand, merchandise imports have been constant to rise in keeping the goods and services balance in deficit. Imports increased by 10.2 per cent, mostly a product of higher imports of intermediate goods. Though, high levels of business investment and strong wages growth has also seen boosting in imports of capital and consumer goods.
Australia’s current account deficit has been anticipated to narrow slightly in 2005-07 as Australia’s trade deficit developed. Export activity is foreseen to pick up in the medium term due to high world commodity prices and higher export volumes curtailing from capital expansion across the economy. (Chamber of Commerce and Industry, 2006)
Australia’s economic growth is projected to remain solid, yet discreet, because of the negative influences of the falling investment of dwelling and high current account deficit. Overall, GDP growth is expected to reach 2½ per cent before intensifying to 3¼ per cent in 2007-2008 as the housing sector stabilizes and higher commodity prices begin to fuel exports even though down from the previous forecast of four per cent. Household consumption growth is anticipated to moderate to three per cent as consumers maintain to re-establish their balance sheets after a continued period of high consumption that conveyed with it higher levels of debt in the household sector.
After recording a modest fall of 0.6 per cent in 2004-05, dwelling investment is predicted to fall by a further 3¼ per cent, consistent with expectations of a soft landing for the residential building sector. Thereafter, housing activity is foreseen to pick up again, with growth of 2¾ per cent expected. Conditions in the business sector continue to stay positive, as confirmed by the strong upswing in business investment evidenced over the years. After growing by a strong 12.3 per cent, business investment is anticipated to grow by an additional seven per cent in the present year as conditions remain supportive.
As high levels of business investment are projected to continue into 2006-07, the rate of growth is expected to moderate to 1¾ per cent. High commodity prices are expected to support a stronger export performance, after the much awaited recovery in the export sector failed to materialize during 2004-05. Exports are estimated to increase by five per cent and by a further nine per cent in 2007-2008. On the other hand, imports are projected to moderate over the next two years in line with a lessening in domestic economic activity, rising by seven per cent in up to six per cent in the current year.
As employment growth is a covering economic indicator, the slower output growth foreseen to bring with it more moderate growth in employment of 1¾ per cent. Having the analysis on Australian economy and its position in the global market and its outlook on the coming years, it can be concluded that the Australian share market is efficient, although unstable at certain points; Australian economy has always been in the world’s list of countries with strongest market structures. (Chamber of Commerce and Industry, 2006)
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