2011 – So many natural disasters
2011 has turned out to be a year of natural disasters, starting with the ﬂoods in Australia, the New Zealand earthquake, the Japanese earthquake, tsunami and nuclear disaster, civil war in parts of the Middle East and North Africa resulting in a surge in oil prices, the US debt ceiling debacle and ratings downgrade, and of course the deteriorating European debt crisis. The combined result has been extremely volatile investment markets and lower than average returns from growth assets.
Despite reasonable company proﬁt growth, share markets have had a rough ride, rising early in the year before falling in the September quarter on worries about a global dip back into recession, partly once again based on European debt woes.
Within global shares, US shares have been a clear outperformer, reﬂecting easier US monetary conditions (low interest rates), the lagged impact of the weak US$ and better proﬁt growth from US companies.
European shares have been amongst the worst performers. Asian and emerging market stocks have been dragged down by worries about inﬂation early in the year, followed by concerns about Europe.
Australian shares performed poorly (albeit falling between returns from US shares and European shares) thanks to relatively higher interest rates, worries about China and the lagged impact of the strong A$, which weighed on earnings growth.
Listed property securities had a ﬂat to slightly up year with their greater income yields offering some protection. The $A met our predicted target of $US1.10 early in the year but has since languished around parity.
However, it hasn’t been all doom and gloom. Unlisted non residential property and Government bonds (except in troubled countries) provided solid returns. Gold made it to a new all time high of above $US1900 an ounce, and rose 22% over the year as investors sought a safe haven against falling values of major currencies.
The lower returns from shares resulted in traditional balanced superannuation funds losing around 1% over the year, a far cry from what is reported in the media on a daily basis.
2012 – A year for recovery
Uncertainty hanging over Europe, and to a lesser degree the US and China, suggests a very uncertain outlook for 2012. However, to borrow from Paul Keating, every pet shop galah is saying the same thing – Europe, Europe, Europe! Uncertainty may already be factored in, leaving some room for cautious optimism. Europe appears to be heading towards a resolution of sorts.
The right action may limit Europe’s growth contraction next year to around -1%. The task is beyond the scope of various bailout funds (which aren’t big enough and are under ratings pressure) and the International Monetary Fund (IMF) does not have enough funds either.
Our assessment is that the ECB is likely to move into top gear in the next six months and buy bonds in troubled countries more aggressively. German opposition to a more aggressive ECB is also likely to fade as its economy weakens.
Second, the US economy looks like it will continue to move forward with growth being held up around 1.5% as solid proﬁt growth continues to support employment and business investment.
Third, China looks like it could slow further in the short term, possibly taking growth to a low point of 7% over the year. However, with the property market and inﬂation cooling and authorities not willing to tolerate a hard landing, policy easing is likely to become aggressive, resulting in overall 2012 growth of 8%. This is pretty much the story in the emerging world as a whole – short term weakness but plenty of scope to provide policy easing as inﬂation subsides.
Pulling all this together suggests:
- Global growth somewhere around 2.5 to 3% next year, composed of 0.75% in advanced countries and around 5% in emerging countries,
- Falling inﬂation as commodity prices remain benign. Spare capacity builds in advanced countries, leading to a possible bout of deﬂation in Europe;
- More monetary easing with falling interest rates in the emerging world and commodity countries, but aggressive quantitative easing in the US, UK and to a lesser degree, the Eurozone
For Australia, this means a difﬁcult environment initially before risks recede later in the year. We anticipate around 3% growth over the next year. Further monetary easing is likely to be required, with the cash rate expected to fall below 4% by end 2012 to help protect growth.
What does this mean for investors?
Shares are now very cheap, particularly against bonds. Forward price to earnings multiples are now 10.2 times for global shares compared to 12.4 times (getting cheaper) a year ago. So while shares may have a rough start to the year, there is good reason to expect them to be higher by year end.
Share markets to focus on are those with strong fundamentals and monetary easing (Asia, emerging markets & Australia) or those with weak currencies and monetary easing such as the US. We expect the Australian S&P/ASX 200 to break through 4800 by end 2012.
Commodity prices are likely to rebound after a possible initial soft patch once it becomes clear the global economy is not going into free fall. Gold is likely to rise through $US2000 an ounce.
Australian house prices are likely to fall another 5% or so in the ﬁrst half as buyers hold back on economic uncertainty. Further interest rate cuts may promote greater conﬁdence, leading to a recovery in the second half.
The main risks are that Europe does not act quickly enough to prevent a major ﬁnancial meltdown and Chinese authorities may react too slowly, resulting in a hard landing (i.e. 6% growth or less).
Australia currently has plenty of policy ammunition with interest rates are well above zero and capacity for government stimulus is ample. The corporate sector is cashed up, the household sector has a strong savings buffer and mining projects impart a degree of resilience. This would all suggest 1-2% growth locally, even if Europe were to head into a recession.
Expect a rough ride, with potential weakness in the ﬁrst part of the year. Uncertainty may prevail but conditions are likely to improve as monetary authorities in Europe and the US take action.
Overall, what many who listen to the print media fear could be a disaster may turn out to be a much better than expected 2012 with strong returns for investors by year end.
 Based on information provided by AMP Capital
 Based on information provided by AMP Capital
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