Apr 21

Economic Outlook

At the time of writing, sharemarkets around the world have experienced one of their strongest six week rallies in history. The push to get the ball rolling was the $1trillion Geitner package that was designed to remove toxic assets from balance sheets. The G20 meeting of world leadersproduced one of the more productive outcomes in recent times and all of this was followed by surprised quarterly profit announcements from some of the biggest American banks in Goldman Sachs, and Citigroup. Whilst the newspapers and various commentators are calling the bottom of the market, there appears to be little evidence suggesting that things are looking up for the economy. The grim reality is that the major economic statistics released in recent weeks have been terrible.

Globally, the International Monetary Fund is predicting the first global GDP contraction since the great depression and that advanced economies will experience deflation during 2009. Deflation is where prices decrease and is just as concerning as high inflation as Japan in the 1990s will attest. For example if prices are declining then consumers are less inclined to spend as prices will be lower tomorrow. This obviously leads to lower profits, less jobs, less spending and the vicious cycle continues. Industrial production around the world is at record lows, credit is still expensive, andthe banks are still writing off enormous assets. Many of the leading economists in the US believe the $1trillion Geitner package is insufficient and should be more in the order of $4trillion otherwise the only hope for the US banks is nationalisation…but in the land of the free nationalisation of a bank is sacriligious.

In Australia, recent months have seen unemployment rapidly increase from just around 4.5% towards the end of 2008 to 5.4% at the end of February 2009. The federal government was forecasting unemployment to peak around 7% by mid 2010 and there is little doubt this figure will be revised upwards in the current budget. Whilst Australia is not technically in a recession (i.e. two consecutive quarters of negative growth) it is just a matter of weeks before a recession in Australia is confirmed. In fact, even before the GDP figures are released Kevin Rudd has announced that “it is inevitable that Australia is dragged into recession”.

The Australian government starting responding to the threats of recession several months ago by announcing their $42billion Nation Building and Jobs Plan, with around $30billion of this to be spent on infrastructure over the next few years. Compared to the rest of the world, the federal government has been very active in attempts to re-accelerate economic growth.

The first Tuesday in March saw the Reserve Bank decrease their cash rates by 0.25% to 3%, which again, compared to the rest of the world is one of the largest and most rapid of interest rate reductions. Unfortunately, whilst bank cash accounts reduced interest rates the same cannot be said for home loans where only a small proportion of the rate cut was passed onto borrowers. In longer term interest rate markets we have seen government bond yields increase substantially in recent weeks. This increase is due to the government required capital raisings to fund their future debt and once again this is not helping those that wish to fix their home loan interest rates. Commonwealth bank announced that they are increasing their fixed rate for all mortgages with terms greater than 1 year.

The outlook for interest rates are further reductions. The Australian government bond maturing in September this year currently trades on a yield of 2.77% indicating at least one and most likely two reductions of 0.25% over the next few months.

Chart 1

The outlook for equity markets both here and overseas continues to be one of volatility. Whilst valuations (as defined by the PE Ratio) continues to be at low levels (Chart 1), the expected decline in earnings (Chart 2) and lack of earnings guidance from companies both in Australia and around the world provides significant uncertainty of potential. As chart 2 shows future earnings expectations are to be below 2005/06 and 2006/07 levels.

Chart 2

With low cash rates, volatile equity and bond markets, and continued economic uncertainty, diversification of investment portfolios is essential. Compared to the rest of the world the Australian economy is better positioned to withstand the slowdown. The government has one of the lowest debt levels in the world and the Reserve Bank still has significant room to move on interest rates. These factors provide opportunity to add further stimulus to our economy to provide jobs and economic growth. Whilst Australia is probably already in recession these factors suggest the slowdown won’t be as bad here as in the rest of the world.

   Send article as PDF   

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

This site uses Akismet to reduce spam. Learn how your comment data is processed.


Get every new post on this blog delivered to your Inbox.

Join other followers: