According to evidence on Friday from US and Europe, the subprime mortgage crisis could impact on investor confidence for some time to come.
We saw some benign economic figures in the July jobs report and the US services sector, plus some comments about the current instability. The markets wobbled, and then fell in late trading.
According to the AMP's chief strategist, Dr Shane Oliver, the fall-out from the US subprime mortgage crisis is likely to have further to run.
He says the uncertainty about the impact on the US economy will be with us for a while and it will take time for investors in credit markets to recover their confidence.
As a result, further downside in share markets is possible in the short term.
Friday's combination of factors sent sharemarkets plunging and US bond yields sharply lower in the biggest fall in 18 month. (see other stories).
There was a small rise in the unemployment rate of 0.1% to 4.6%, as a consequence of fewer than expected jobs in July at 92,000 (which would have normally been seen as good news and confirming no reason for a rate rise) Then there was the softening in the performing of the US service sector: normally not a potent mixture, but late Friday it was certainly that.
That weakness was amplified by a dire warning from the chief financial officer of Bear Stearns, the embattled US investment bank which has been placed on credit watch negative by a key rating agency, Standard & Poor's.
The CFO said the current instability was the worst he'd seen in 22 years in the markets and all of that was enough to bring the bears out and the Dow and other indices plunged.
Now, those statistics would not have done that to market confidence six weeks ago: a month ago, they would have ruffled confidence, but not knocked it for six like they did late Friday in the US.
With copper prices falling sharply on Friday, oil down as well, but gold up, there will not be the support in Australian markets like there was last Monday.
The Share Price Index on the ASX200 had our market down around 123 points or 2% when trading finished Saturday morning. That would put the index and the All Ords down under the 6,000 point mark.
That was after the sharp tumble on Wall Street.
The S&P 500 wiped all the week's gains on Friday, falling 39.14, or 2.7%, to 1433.06 in its worst day since February 27. The Dow slumped 281.42, or 2.1% to 13,181.91. And the Nasdaq fell 64.73, or 2.5% to 2511.25.
The Dow's 585 point fall was its biggest weekly percentage drop since March 2003.
The sell-off exacerbated a rout last week that wiped $US2.1 trillion in value from global equity markets, according to an estimate from Bloomberg.
Shares declined in Europe, with indexes down in all 18 western European markets except Luxembourg. Asian markets also had a down week.
In Australia we lost around 1.2% to 1.3% on the major benchmarks.
For the week, the Dow fell 0.7%, the S&P 500 1.8% and Nasdaq 2%.
So far this year all three major U.S. stock indexes are still positive: the Dow is up 5.8%, the S&P 500 is up 1.04% and the Nasdaq is up 3.9%.
The S&P 500 has lost 7.7% since July 13 and that is the worst three-weeks since 2003. Our market is off around 6.2%.
The AMP's Dr Oliver said in his weekly note on Friday that we are also entering the seasonally weak August to October period, so the rough patch could last several months.
"Over the last two years corrections have been coming along every 6 to 9 months and have been ranging from top to bottom falls of between 7% to 12% for Australian shares spread over a month or so.
"Given the tendency for corrections to be larger and sharper the more advanced the bull market becomes (think of the 20% fall in Australian shares between September and October 1997 which was in the midst of the late 1990s bull market), the correction this time around could potentially be somewhere around 15%.
"However, while the falls so far have been steep we remain of the view that this is just another correction, albeit possibly more severe than those of the last few years, within a still rising trend.
"The global and Australian economies remain in good shape with US weakness being offset by strength elsewhere, inflation and interest rates remain relatively low, share valuations are attractive and the corporate sector is in good shape with low gearing and solid profit growth.
"While funding for private equity buyouts may have dried up for now, other sources of liquidity for investment markets remain intact. US companies are buying back their shares at a record rate and the flow of capital from Asia is not going to dry up any time soon.
"By year end I anticipate the Australian share market to be well above current levels (up around 6700 for the ASX 200). Australian shares are now trading on a forward PE of 14.5 times, which is down from 15.6 times two weeks ago and well below its 10 year average of 15.2 times.
"Bond yields are likely to range trade with the risk on the downside given worries about the US economy.
"The fall in $A looks like a correction after a sharp rise. With commodity prices likely to stay high and the interest differential likely to widen versus the US, the $A is still likely to head up to the February 1989 high of $US0.8950 by year end."
