Welcome to our final Market Wrap for 2011. We would like to take the opportunity to thank you for your support throughout the year and to wish you and your family a happy and successful New Year.
2011 has been a year full of disasters with floods, earthquakes, civil wars in the Middle East, and of course public debt woes in Europe and the US. Fears of another global financial crisis and a return to global recession have resulted in a rough ride for share markets.
Outlook for 2012 – bad then better?
Uncertainty hanging over Europe, and to a lesser degree the US and China, suggests a very uncertain outlook for the year ahead. However it’s worth noting, to borrow from Paul Keating, every pet shop galah is saying the same thing – Europe, Europe, Europe! So maybe it’s all factored in and – perhaps after an initial messy period, it won’t be so bad. There are several reasons for a bit of cautious optimism.
• First, Europe appears to be heading towards a resolution of sorts, which is likely to involve much greater ECB intervention, helping to limit Europe’s growth contraction next year to around -1%.
• The only organisation that can bring the debt contagion under control is the ECB. Our assessment is that it is likely to move into top gear in the next six months – and buy bonds in troubled countries more aggressively.
• Second, the US economy looks like it will continue to simply muddle along, perhaps even with another “double dip” worry around mid year, but growth being held up around the 1.5% level by more quantitative easing and solid profits supporting 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% year on year. However, with the property market and inflation cooling and the authorities not willing to tolerate a hard landing, policy easing is likely to become aggressive, resulting in overall 2012 growth of 8% in China.
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, albeit looking worse earlier in the year before improving in the second half
• Falling inflation as commodity prices remain benign and spare capacity builds in advanced countries, leading to a 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 Europe (ie just enough)
• Intensifying currency wars as quantitative easing sees the $US, euro and sterling remain weak
• Constrained earnings growth reflecting the soft overall economic backdrop.
For Australia this means a difficult environment initially, before risks recede later in the year. Our base case is for 3% growth over the next year – ie better than the 2011 which was affected by the drought, but it probably will require more monetary easing with the cash rate expected to fall to 3.75% by end 2012 to help protect growth.
So what does this all mean for investors?
• In the short term it’s hard to feel confident on shares and related risk assets, as much uncertainty hangs around Europe and global growth could first get worse before it gets better. However, against this, shares are now very cheap particularly against bonds, monetary policy is easing further and everyone is bearish. So while shares may have a rough start to the year, there is good reason to expect them to be higher by year end.
• The $A is likely to have a few rough patches, but is likely to remain strong overall, ending higher in response to more QE in the US and Europe, Australia being one of the few countries with a stable AAA rating, and as investors start to anticipate better commodity prices.
• Cash and term deposits are likely to become less attractive as cash rates continue to fall, pulling down term deposit rates with them.
• Unlisted commercial property returns are likely to remain reasonable reflecting yields around 7%, requiring only modest capital growth to generate a decent return.
• Australian house prices are likely to fall another 5% or so in the first half as buyers hold back on economic uncertainty, before rate cuts reach a critical mass and greater confidence leads to a recovery in the second half.
What are the risks?
The main risk is that Europe does not act quickly enough to prevent a major financial meltdown and deep recession. If so, this would drag the global economy back into, or very close to recession. There is also a risk in China that the leadership transition and a desire to quash property speculation sees the authorities react too slowly to the slowing economy, allowing a move to a hard landing (ie 6% growth or less) to become entrenched.
If the world really does go back into recession, fortunately Australia has plenty of ammo to fight it off – rates have a long way to go to zero, the $A will fall if things fall apart globally, there is more room for fiscal stimulus if needed, 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, but not recession.
Conclusion
Expect a rough ride, with potential weakness in the first part of the year. Conditions are likely to improve as monetary authorities in Europe and the US step up to the plate. So overall what many fear could be a disaster could turn out to be much better than expected.
From Dr Shane Oliver - Head of Investment Strategy and Chief Economist - AMP Capital Investors
Indices:
The All Ordinaries Index has moved down over the calendar year (4/1/11 to 20/12/11) decreasing a 742 points or -15.3%.
The rest of the world as measured by the MSCI index is down 122 points (3/1/11 to 20/12/11) or -8.7% for the calendar year.
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