Market Outlook - Summer 2009

Mainstream economic forecasters were correct in their predictions for the 2009 year. They anticipated a difficult year for the major world economies with a return to growth towards the end. They also predicted that share markets would start to recover in anticipation of a recovery. The prediction of recovery was not remarkable, but getting the timing right was. Recessions never go on forever and markets generally fall by far more than they should when things look bad and recover quickly when things stop getting worse.

The greatest financial crisis since the 1930’s now looks to be behind us and we await the aftermath. It would be foolish to assume there will not be one. Serious amounts have been lost, government debt in most of the western world is high, and credit markets are still difficult. International economies are likely to continue recovering but much of this is already built into share prices.

Plenty has been written about Australia dodging the worst of what the rest of the developed world has experienced. Our companies now have strong balance sheets, our unemployment rate has remained comparatively low, and our banking system has survived. Despite this good performance, we are still at the mercy of the rest of the world and restrained world growth will constrain our own although there is a distinct shift in focus to the emerging giants from the mature economies.

Even after the spectacular market returns of the past nine months, all share markets are still well below their historic highs. It is likely those highs were a little too high. A return to the previous levels may still be some years away and, at some point, the markets are likely to go through a period of consolidation seeking a clearer direction for the future. We may see some seasonal strength through the next few months but it would be foolhardy to assume future returns similar to those experienced since March 2009.

Interest rates in the rest of the world are likely to remain low for some time, but in Australia they will continue rising at a steady rate. The Reserve Bank wants to reduce the stimulus that low interest rates provide and move to what they call a neutral setting. In essence this would have rates increase by around 1-1.5% from where they are now, probably over the next eighteen months.

The strength of the Australian Dollar has been a little surprising but it really reflects the unexpected strength of commodity markets – especially the prices of energy and minerals. Fears that the commodities boom was over, or at least stalled, were unfounded – it seems to be alive and well. This, along with our increasing interest rates and relatively strong economy could see the currency strengthen further.

Interest bearing investments are an important component of many investment portfolios and the best idea is to retain exposure to higher quality, term investments within Australia.

Coming out of a recessionary period the share market is usually the first investment market to recover. Property and infrastructure investments have to wait their turn. Australian residential property has retained far more of its value than residential property in other parts of the world, and now appears expensive by comparison. This has led some to predict a savage slump in housing prices, but given the low supply and high demand in Australia this has not happened yet and it may not. People are unlikely to move overseas for a cheaper house. In fact, Australia has a rising population largely due to immigration.

Commercial property, on the other hand, has been substantially written down in value, even though very few transactions of substance have actually occurred. Occupancy rates in our major cities continue at high levels, there is little oversupply and, with financing tight, there is not a lot of new supply on the way.

Many property and infrastructure investments listed on the share market have suffered through the crisis. In retrospect, they had more debt than they should have had and most have now raised capital to improve their position. Despite this, they continue to trade at prices below the underlying asset backing and over time this anomaly will disappear. Both property and infrastructure were seen as conservative and low risk investments in the past. But, due to debt issues, they have been the most difficult investments through this period.

The investment cycle that sees support for property and infrastructure investments follow the broad share market is still in place. Maintaining reasonable exposure to these investment markets will eventually prove rewarding. This prediction is not remarkable, it will happen – we just don’t know when.

After the experience of the past two years you can expect economic forecasters to remain circumspect about what is likely to happen next. They did well a year ago because the future from where we were then was reasonably obvious. The outlook for markets and economies over the next twelve months is less so. The next five years, however, are likely to be positive and maintaining your strong portfolio of quality assets will provide good returns.