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May 06

The extreme but possible storm ahead

Attended a Researcher’s conference yesterday which had an interesting line-up of speakers that covered China, the global economy, Small cap stocks, and . The first guy was very impressive, an investment Strategist, he did a “Me-style” global economic presentation (perhaps that’s why I liked him) where the key points were…

  1. Commodity Prices in a  bubble
  2. Australian house prices in a bubble
  3. China must/will slow, given inflationary pressures, and internal asset bubbles
  4. Australian dollar at irrationally high levels
  5. Euro Sovereign crisis must result in defaults for Greece, Portugal, Ireland,
  6. US economy is stuffed and recovery will be slow for many years

Whilst these are extreme views its not difficult to make a case for any of them. His markets forecast was that he was forecasting global shares to outperform Australian shares…fine. BUT, he then articulated that he was still quite confident in the Australian economy, Australian sharemarket and that our interest rates will rise (which is clearly a consensus view).

My comments…how on earth can anyone (and many do) agree on points 1,2,3, and 5 and not think our economy (and sharemarket) is facing a potential perfect storm (I actually put this question in these words to him)? To me unfortunately  his conflict of interest, as a fundie, got in the way of his answer. Either way, I’m also a little concerned about points 1 through to 3 (or even 5 given our reliance on the global banking system…point 6 is a factored in and its likely impact other than to keep the US dollar weak) and the downside risks to our economy and markets. If interest rates do go up, then that could be the catalyst to set off point 2 which could flow into the financial system and the rest of the Aussie economy and therefore sharemarkets. If China slows, as Nouriel Roubini is forecasting along with many others, then the biggest impact on our market will be the impact on point 1 (although aided by a cushioning effect from point 4 also dropping) which could be quite shocking (~35% of our market is Resource based).

I’ll end by quoting Jeremy Grantham from his latest newsletter, “beware the sell-side strategist offering arguments as to why overpriced markets are actually cheap”…whilst the analyst wasn’t necessarily saying assets were cheap he was denying the potential impact of these expensive markets on our own therefore suggesting our market is fairly priced…unfortunately given the downside risk I’m not so sure.

Plenty of food for thought.

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1 comment

  1. BB

    To borrow from Play School….. “There’s a bear in there!” 🙂

    I too find it interesting how someone can spend 90% of their presentation submitting evidence contrary to their eventual conclusion. At a recent dealer group conference Bruce Johnston (Fidelity) painted a very bearish picture for the long term economic outlook of the US and Europe and their capital markets, although apparently (as I’m yet to see the full presentation), 10 minutes before the end it was suddenly time to talk positives (perhaps forced to remember by whom and how much he was being paid to be there?).

    Now I’m not aware of his thoughts on China (Fureyous Point 2.) and shoot me for being simplistic (or non academic) but here are some points that just don’t make rational sense to me:

    1. China is still expected to top the list of world nations for fixed asset investment as a % of GDP (est at 47.80% for 2010). I can’t recall the most recent study but to my memory multiple ones have been written examining the history of unsustainable fixed asset investment and economic failures (aka Japan). With a good deal of your population still in rural farming communities how many airports, high speed trains and apartment blocks can you really need? I also came across and interesting piece citing a marketing announcement from a Chinese Steel producer who has launch a range of premium wines, why? “because steel production margins are too low”.

    2. Ok ok, china is an emerging economic powerhouse, growing industrial productivity, accumulating foreign reserves, the sky is the limit etc etc. So how is it they are still running yearly budget deficits? Surely the nation “profiting” from the over consumption of every other nation can at least balance the books?

    3. GMO’s quarterly letter also makes reference to world metal prices “The highest percentage of any metal resource that China consumes is iron ore, at a barely comprehensible 47% of world consumption”. Come again? So we have a national injecting near 50% of its GDP into all things tall and shiny and as a consequence it accounts for nearly 50% of the WORLD consumption for this one resource? The long term sustainability of this is demand is one issue but certainly the consequences for Australia in a china slow down situation seem beyond question? I also find it very surprising that Jeremy uses this as an argument for a “paradigm shift” in world metal prices? (mind you his assertion has not been lost on mainstream finance, I have seen his recent report quoted in no less than 5 separate sources as “confirmation of the continued boom in commodities”

    Silly Questions? Am I just misunderstanding the complexities of modern economics? I don’t know, but with limited artificial market stimulation in Australia and the ASX failing to make any real ground since late 2009 perhaps our market is one of the few that this uncertainty is not lost on?

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