This economic update has been reproduced from AMP
Capital Investors Chief Economist Dr Shane Oliver.
2009 has been a year of recovery
At the start of 2009, fear of a complete financial
meltdown was rife. There was doubt as to whether the
massive and unrelenting stimulus and financial rescue
efforts put in place around the world would work, and
many were talking of a re-run of the Great Depression.
As a result, share markets and other assets
continued to plunge in March.
However, the key message from governments and
central banks
in most countries was that they would do whatever it
took to
head off depression and restore asset prices. Budget
deficits in
some countries were pushed up to 10% of GDP and
several central
banks moved beyond near zero interest rates to
embark
on 'quantitative easing'.
And it worked!
Just when it seemed that all hope was lost,
the
gloom began to lift in March. Shares bottomed, credit
markets
unseized, commodity prices started to rebound, bank
losses
started to recede and the 'green shoots' of economic
recovery
started to pop up. Talk of a false rebound was
common. However,
as the green shoots turned into saplings and the
recovery in
share markets continued, it became apparent that the
massive
worldwide economic stimulus had traction.
But while growth has rebounded, underlying inflation
pressures
have continued to slide reflecting the massive amount
of
global spare capacity. As always, inflation is a lagging
indicator.
Similarly, unemployment and private sector credit are
also lagging
indicators. Unemployment has increased to around
10% in the US
and Europe, although there are signs that it is close to
topping.
Perhaps the biggest surprise over the last
year has been the Australian economy. It has
managed to avoid recession and then
has had a surge in unemployment, despite
widespread fears to
the contrary. Australia is about the only advanced
country to have
had positive GDP growth over the last year. This can
be attributed
to solid export demand, a sound financial system and
the rapid
and massive economic stimulus. Australia has yet
again proved
itself to be the 'lucky country'. Reflecting this, the
Reserve Bank
of Australia (RBA) has been one of the first central
banks to start
raising interest rates.
The key winners over the last year have
been Asian and emerging markets generally (with
gains of around 55%), commodity prices (with metal
prices up 80% and gold up 30%), Australian shares
and corporate debt.
Global shares have increased in local
currency terms.
However,for Australian investors the gains have been
wiped out by a
sharp rise in the value of the Australian dollar (A$).
Cash and government bonds have been
poor performers, with
the latter dragged down by a rise in yields from low
levels as
fears have subsided.
After holding up reasonably well in 2008,
unlisted property
returns fell sharply in a lagged response to credit
problems and
the collapse in share markets.
By contrast, Australian housing saw positive
returns in response
to the first home owners boost, the earlier collapse in
mortgage
rates and the boost to confidence.
As shares are the dominant investment in
most super funds, this
all translated into a recovery for investors.
The key lessons of the last year were that counter
cyclical macro
economic policy measures do work, that just as the
cycle goes
down it also goes up, and that markets always bottom
just at the
point of maximum gloom.
Outlook for 2010
In direct contrast to the doom and gloom of a
year ago, the
outlook for 2010 is reasonably bright. Sure, the
aftershocks from
the global financial crisis - such as high
unemployment, periodic
debt blow-ups (Dubai, Greece, etc) and constrained
bank lending
will linger. But as 2010 progresses, the global
recovery is likely tobecome increasingly self
sustaining. In this regard, the key themes of relevance
for investors for 2010 are likely to be:
1. A self sustaining economic
recovery. Leading economic
indicators point to continued growth over the year
ahead. But
most importantly, signs that labour markets are starting
to
turn the corner - notably in the US - suggest the
recovery is
on its way to becoming self sustaining. In other words,
fiscal
and monetary policy has primed the pump and the
private
sector will now take over. 2010 is likely to see global
growth of
around 4% (up from 0.8% in 2009, which primarily
reflects the
late 2008/early 2009 slump).
2. Stronger growth in the emerging
world. Thanks to stronger
domestic demand and less in the way of structural
constraints
such as debt and demographics, growth in the
emerging
world is likely to be 7% compared to around 2.5% in
advanced
countries in 2010. China is likely to grow by 10%,
India by 8%
and Brazil by 6%.
3. Benign inflation. Inflation lags
economic activity because it
reflects capacity utilisation, which is below normal well
into an
economic recovery. This time is no different except
that excess
capacity is greater than normal, with the result that
underlying
inflation is likely to continue to fall in the year ahead.
4. A gradual move to wind back the
stimulus. Along with the
economic recovery there will eventually be pressure to
wind
back budget deficits and raise interest rates. Talk of
higher
interest rates and uncertainty about how aggressive
the wind
back will be, will no doubt fuel occasional corrections
in asset
markets over the year ahead, particularly in those
markets that
have benefitted the most from low US interest rates.
Namely,
emerging markets, commodities and commodity
currencies -
much as occurred in 2004 when the Federal Reserve
(the Fed)
last moved to tighten. However, tightening will be a
very slow
process in advanced countries, given memories of
premature
tightening in the US in the 1930s, still very high
unemployment,
and falling underlying inflation. Global central banks
will first
move to unwind the liquidity stimulus before starting to
raise
interest rates during the second half of 2010. Interest
rates will
still be very low by the end of 2010 - maybe around
1.5% in the
US. China is likely to move a bit more aggressively to
tighten,
but it is not as dependent on stimulus measures.
5. Earnings recovery. As the
economic recovery becomes
entrenched, earnings growth will return and take over
as the
key driver of share market gains. Profit growth is likely
to be in
the order of 20% in the US and Australia, and 30% or
more in
emerging countries.
6. Australian economic growth to
rebound but underlying
inflation to slow. The rebound in business and
consumer
confidence, a housing construction recovery,
numerous mining
projects, and increased public infrastructure spending
are
expected to underpin GDP growth of around 4%
through 2010.
This is likely to see unemployment return to around
5.5% by
year-end. Inflation is likely to be 2.5% thanks to a
combination
of global excess capacity and the impact of the strong
A$.
While the RBA will continue to raise the cash rate, the
process
is likely to be gradual, taking it to around 4.75% to 5%
by
year-end, with low inflation and additional increases in
bank
lending rates stopping a more aggressive rise.
Looking at the major asset classes for the year ahead:
Share markets are likely to rise
further, thanks to the combination
of improving economic and profit growth, low inflation
and
sustained low interest rates at time when there is still
plenty of
cash on the sideline. However, shares are moving
from a multiple
driven phase to an earnings driven phase. This, along
with moves
towards higher interest rates, will likely result in more
volatile
and constrained gains than has been the case since
March. The
Australian ASX 200 and All Ords indices are expected
to rise to
around 5600 by the end of 2010 and we see
Australian shares
continuing to outperform traditional global shares,
reflecting their
higher dividend yields and stronger growth prospects.
Asian and emerging markets are
likely to remain out performers
reflecting better growth prospects. However, the ride
will be
more volatile.
Commodity prices and the A$ are
likely to remain solid off the
back of the economic recovery, with the A$ breaching
parity.
However, expect occasional sharp corrections when
the Fed
moves towards tightening.
Cash remains unattractive long term,
reflecting low interest rates. Cash
returns are likely to be around 4.5%.
Government bond yields are likely to
push higher later in the
year as monetary tightening starts to be factored in.
Corporate
debt is far more attractive with yields of 7.5% or more.
Unlisted non-residential property is
likely to see positive returns on
the back of yields of around 7% and modest capital
growth. This is
thanks to more favourable space demand/supply
fundamentals,
less selling pressure and increased investor demand.
Average house price gains are likely
to slow as mortgage
rates rise and the first home owners boost comes to an
end.
A stronger labour market will provide some support
though.
Overall, expect average house price gains of around
5%.
Our return expectations imply that most super funds
should see
continued gains through 2010.
US consumers and premature tightening are the
main risks
The two big risks are that US consumers
return to cutting spending
and paying down debt and/or that policy makers start
tightening
too aggressively, too early. However, a stronger
labour market should
help US consumers. It also seems that policy makers
are keen to
avoid a re-run of Japan in the 1990s and the US in the
1930s, when policy
was tightened too aggressively. China is also worth
watching.
Conclusion
The last year has told us that just as the
investment cycle goes
down, it also goes up. Right now, it is still early days in
the
upswing and so growth assets, like shares, are likely
to continue to
do well over the year ahead.
Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital Investors
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