After writing endlessly about Europe last year, I was determined that it would not be the subject of my first note this year, despite recent rating downgrades.
Instead I thought I would summarise key views on the global economy and investment outlook in simple point form – in other words, a list of lists.
The key themes for 2012 are:
- Fiscal austerity and deleveraging in Europe and the United States.
- Monetary reflation with quantitative easing in Europe, the US, Britain and Japan and rate cuts in the emerging world and Australia.
- The emerging world once again to account for most global growth.
- Global growth of 3 per cent, at 1 per cent in advanced countries, 5 per cent in emerging countries and 3 per cent in Australia.
- Falling inflation and price deflation in some areas due to spare capacity.
- A volatile first few months in the markets due to continuing European woes, but improving conditions and returns as markets start to anticipate the next economic upswing helped by attractive valuations and easier monetary conditions.
The main risks for 2012 are:
- Europe fails to reflate sufficiently or in time, resulting in a deep recession and possible break up of the euro.
- The US fails to extend payroll tax cuts and unemployment benefits.
- China eases too late to prevent a property crash and hard landing.
- Tension over Iran leads to a growth-threatening surge in oil prices.
Key indicators to watch are:
- The spread to German bond yields for Italy, Spain and France.
- Chinese money supply growth – it has recently bounced off a decade low, but should improve if policymakers continue to ease.
- The US ISM manufacturing conditions index – downturns forecast in mid-2010 and mid-2011 inspired false double-dip alarms.
- The Australian dollar is a good indicator of global growth – if it stays up things are OK. So far so good.
Five reasons why the emerging world is in reasonably good shape:
- Low public and private debt levels.
- Low per capita income levels means huge potential for further catch-ups in living standards and hence urbanisation and industrialisation.
- Inflation is falling, clearing the way for more monetary easing.
- The monetary transmission mechanism still works.
- Generally sensible economic management.
Seven reasons why Australia would be unlikely to follow if the world goes into recession:
- Long way to go to zero for interest rates. Roughly 85 per cent of mortgages are on variable rates and hence households get a huge boost to spending power as rates fall.
- Low public debt by global standards means scope for fiscal stimulus.
- The Australian dollar will fall if need be, providing a buffer.
- Companies have low gearing and are cashed up.
- Households have high savings rates, which provide a buffer.
- The mining investment boom provides resilience.
- Our trading partners are in reasonable shape.
What investors should consider in the current environment:
- The cycle lives on – history tells us that times of gloom will eventually give way to boom and vice versa. There is no such thing as a new era, new paradigm or new whatever. As the Bible tells us, there is nothing new under the sun.
- The power of compound interest – regular investing of small amounts can compound to a big amount over 20-year-plus time frames.
- Buy low and sell high – starting point valuations matter. The lower valuations thrown up by market weakness provide opportunities for far-sighted investors.
- Focus on investments giving decent and sustainable cash flows, such as dividends, distributions and rents. They are a good guide to future returns, a sound buffer in volatile times and provide useful income.
- Invest for the long term but for those with a short-term horizon, such as those close to or in retirement, consider investment strategies targeting desired investment outcomes whether in the form of a targeted return or cash flow.
- Avoid the crowd – just as it got it wrong when it piled into the “Japanese miracle” in 1989 (Japanese shares fell for the next two decades), the “Asian miracle” of the mid-1990s (which turned into the Asian crisis of 1997-98), the “tech boom” of the late 1990s (which became the tech wreck of 2000-03), the credit and US housing booms of the middle of the last decade (which turned into the global financial crisis), the crowd might also find that the dash for cash of the past few years will ultimately prove to be wrong over the next five years or so.