2012 – A year for recovery
- 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
In the end this was pretty much what was delivered with
- Global growth around 3%
- Benign inflation throughout most of the world
- More rate cuts, “quantitative easing” – ie money printing
For investment markets, we predicted:
“So while shares may have a rough start to the year, there is good reason to expect them to be higher by year end”
“We expect the Australian S&P/ASX 200 to break through 4800 by end 2012”
“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”
“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”
“China looks like it could slow further in the short term, possibly taking growth to a low point of 7% over the year”
“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.”
- The Aussie sharemarket up around 13% for the year,
- The S&P/ASX 200 just 3% shy of our prediction at 4649
- House prices down early but some signs of flattening to recovery late in the year
- Commodity prices rebound with Iron Ore dropping below $90/tonne before rebounding to $145/tonne. Despite further money printing Gold however peaked at $1,795, ending the year around $1,665
- China’s growth bottomed around 7.5%
- Overall double digit returns for most major investment markets
Despite the considerable predictions of further doom this time last years, in the end 2012 will go down as a year of solid to strong returns with and many areas still reasonably priced to cheap, there is certainly room for further gains into 2013.
2013 – Tail risks diminishing
First, the cyclical pattern since the 1970s has been to have major recessions every 8-10 years (mid 1970s, early 1980s, early 1990s, early 2000s, late 2000s) with modest growth slowdowns in between. We still appear to be following this pattern, with the global growth slowdown of 2012 largely anticipated by the 20% top-to-bottom falls in sharemarkets seen in 2011. If this, albeit imperfect, pattern is correct then the 2012 global growth slowdown has cleared the way for a continuation of the global recovery for the next three years or so which should help underpin growth assets.
Second, the risks around Europe remain high particularly with the Italian election expected in February and a likelihood that Spain will have to apply for assistance from the bailout fund and the ECB in the next three months. However, the ECB’s funding intervention in banks, it’s threatened bond buying program and the Eurozone’s ragged but seemingly dogged determination to head towards more Europe not less, suggests that the risk of a blow up in Europe will continue to recede. In the meantime declining inflation and continued recession will see more monetary easing helping clear the way for an exit from recession during the second half.
Third, while the fiscal cliff of budget tightening is a near term hurdle for the US there is a 90% probably it will be solved by end of January (as the political consequences for both parties in triggering a recession are just too big). But once the US clears this hurdle the US should have a reasonable year in 2013 as the housing recovery adds around 0.75% to growth, shale oil and gas continues to revolutionise the US, capital spending rebounds after uncertainty associated with the fiscal cliff and quantitative easing spurs growth.
Fourth, China looks like its on track for growth around 7.5% at least with the slowdown behind it. Growth in Asia, Brazil and India should also stabilise and begin to improve, following significant monetary easing.
Pulling all this together suggests:
- global growth somewhere around 3.25% in 2013, ranging from a mild but fading recession in the Eurozone, 2.5% growth in the US, 5.5% growth in the emerging world and 7.5% growth in China;
- benign inflation in response to 2012’s growth slowdown and spare global capacity;
- continued low interest rates and quantitative easing leading to a very easy and growth supportive monetary environment; and
- a stabilizing then improving earnings growth reflecting the improving economic backdrop.
For Australia, growth is likely to remain subdued initially as mining slows and non-mining is slow to pick up. This is likely to see unemployment rise to around 6%. Against this backdrop the RBA is likely to cut rates further to 2.5% in order to push bank lending rates down closer to past cyclical lows. However, as the impact of rate cuts starts to feed through with normal lags, growth should start to improve by year end. Overall we see: growth around 2.5%, but this is masking a second half upswing; inflation remaining benign; and the cash rate falling to around 2.5% in the first half.
What does this mean for investors?
Against a back ground of a modest pickup in global growth and gradually receding risks in Europe, growth assets are likely to continue to do well but the returns from bonds are likely to be limited.
- Shares are likely to provide another solid year of returns. Shares are very cheap against bonds as bond yields have fallen further and should benefit from ultra-easy monetary conditions globally and the anticipation of stronger profit growth in 2013-14. What’s more while sentiment towards shares is not as bearish as it was in late 2011 it is still very cautious at a time when share weightings have collapsed.
This suggests there is plenty of money to come into shares once confidence starts to pick up. Worries about Italy and Spain could trigger a bout of volatility around February/ March, but overall returns are likely to be solid.
- While US shares have been a star performer, helped by more aggressive monetary easing, this may be starting to change. Our assessment is that European and Asian shares are likely to be the star performers in the year ahead reflecting relatively low price to forward earnings ratios of around 10 times, compared to around 12 times in the US, the gradual pricing out of disintegration risks in Europe and stronger growth prospects in Asia.
- Falling interest rates and improved sentiment towards China are likely to see Australian shares do well, but uncertainties about the growth and profit outlook will act as constraints. We expect the Australian ASX 200 to rise to around 5000 by end 2013. Bombed out cyclicals such as resources along with yield plays like telcos are likely to outperform.
- The $A is likely to fall to around parity as the combination of a narrowing interest rate gap, slowing growth and a widening rade deficit offset the impact of more US quantitative easing.
- Cash and hence term deposits are likely to become even less attractive as cash rates slide to 2.5%, further pulling down term deposit rates well below 4%.
- Historically low starting point bond yields suggest low returns from sovereign bonds, unless global growth takes a renewed leg down. Australian bonds are a bit more attractive than global bonds given higher yields. Corporate debt is a better bet for those after income.
- Property securities are likely to continue to benefit from investors seeking yield, however returns are likely to slow after the 20 to 30% returns of 2012.
- Unlisted commercial property and infrastructure are likely to benefit from relatively attractive returns and strong investor demand given their relatively attractive yields, eg around 7% for commercial property.
- Australian house prices are likely to see a modest 4-5% bounce on the back of lower mortgage rates.
What are the risks?
The main global risks relate to US budget and debt problems and a relapse in Europe perhaps triggered by renewed worries regarding Italy or Spain. An alternative risk is that growth surprises on the upside triggering a mass investor switch out of bonds resulting in a sharp back-up in bond yields.
In Australia, the main risk is that the non-mining sectors of the economy eg housing, retailing, tourism, etc, take longer than expected to pickup pace leading to a sharper slowdown in growth beyond the 2.5% we are expecting. This could occur, for example, if rising unemployment triggers a desire on the part of households to more rapidly reduce their debt levels. This could see the RBA cut the cash rate to 2% or below.
In the end 2012 turned out much as we expected, not because of our superior psychic skills or any unique crystal ball but more through an objective and dispassionate look at the fundamentals. Some things often are a lot more predictable if you focus on the fundamental drivers. The timing is virtually impossible to predict, but the destination is reasonably so. Also, things are rarely as good or bad as they can seem.
We expect 2013 to again be an overall good year as the conditions continue, on the whole, to improve. Notwithstanding there is still much to resolve (e.g. all that debt hasn’t been repaid yet), however the path to resolution is becoming clearer. Sure there’ll be problems along the way and a hiccup or two, but there is certainly plenty of opportunity as well.
I get the biggest kick out of helping people, particularly people who aren’t afraid to dream big and say that anything is possible. In the beginning most of my clients come to me with a problem or an irritation that they want to deal with, once we get over this initial hurdle we quickly get on to designing an amazing future for themselves and their family.