“Cautious optimism”, “mixed signals”, “muted confidence”: all terms commonly used to describe the current state of affairs in the global economy and investment markets. The incidences of “recession” and “depression” being used in the media have substantially receded with most of the major Western countries now moving into the slow, and what is believed to be, a fragile recovery in the wake of the Global Financial Crisis.
While harsh winter conditions saw much of the northern hemisphere snowed in, growth rates in most developed nations have thawed. The last of the major economies, Britain, moved out of recession in the last quarter of 2009. Across the Atlantic, the US recorded a stronger than expected annual growth rate in the December quarter and corporate profits continued to improve on the back of cost cutting strategies. While growth has returned, it looks likely to moderate through 2010 as households reduce debt and governments withdraw stimulus.
It has been an eventful start to the year with a return to higher volatility on share markets as they react to the regular delivery of positive and negative news. There have been questions hanging over some of the European countries and the magnitude of their government debt. However, as we have seen throughout the ‘GFC’, solutions are found for most of the problems that arise. The stronger states in the European Union have stepped in to ensure the viability of the countries in question.
A two-speed recovery will continue with emerging countries outpacing the large developed economies. The strength of the major emerging markets, in particular increased public and private investment and rising consumer spending in China and India, is expected to push global economic growth to 3.9% for 2010. In fact, China overtook Germany as the world’s largest exporter in 2009 and is on track to displace that country as the world’s second largest importer, after the USA. Australia is expected to grow its economy by 3.25% in 2010 and concerns are now around attracting skilled labour to fill impending job vacancies.
Interest rates remain low globally while in Australia the Reserve Bank took a break from hiking rates in February to assess the impact of recent rises on the economy. More increases are expected locally through to 2011 but in most other developed nations interest rates look set to remain on hold.
Australia is a developed economy and our strong performance compared to others is due largely to our close connections with emerging countries, the strength of our banking system, and our comparatively low government debt. As a result, the Government has decided it is time to remove one of the measures put in place to ensure stability in the financial system.
The Wholesale Funding Guarantee for bank deposits, a fee put in place in late 2008 to give our banks continued access to overseas funding with the backing and security of the Government, will be removed. The guarantee for small deposits will remain in place for the time being. High quality bank term deposit rates remain at attractive levels with banks competing for investors’ capital to diversify their funding base. This competition is likely to continue for the foreseeable future driven by changes being considered to banking regulations globally to ensure the risk of another financial system meltdown is minimised.
The recovery in share markets has been nothing short of remarkable. In Australia the reporting period has confirmed the strength of many of our blue chip companies and the Australian economy. Investors who remained invested through the worst of the crisis have been rewarded as the market here recovered 45% from the depths of March to the end of 2009. Investors now seem to be focussing on the fundamentals, with panic selling no longer dominant and positive sentiment returning. It seems to us that the very easy gains have been made.
After significant capital raisings last year when banks reduced lending, many companies are now in very strong funding positions and in time this capital and increasing access to debt is likely to be deployed in merger and takeover activity; a time when the strong get stronger and the weak look for alternatives. In the absence of a new deterioration of economic conditions we would expect to see more takeovers, both in Australia and overseas, as the year progresses and into 2011.
Property markets also appear to be past their worst. Valuations in December reduced by much smaller amounts than they did in June last year. This was due to fewer than expected distressed sales, easier access to finance and the underlying strength of most tenants ensuring vacant space didn’t escalate to the levels seen in previous downturns. Differentials remain between asset values and some market prices in listed property, providing a margin of safety for investors seeking opportunities.
Residential prices have remained resilient compared to other nations. Assuming new home owners haven’t overextended with such low interest rates, it remains hard to foresee any significant concerns arising in Australia where economic conditions remain robust and population growth is strong and rising.
The May Federal Budget is likely to have a packed agenda, leading into an election in early 2011 and with possible emission trading legislation and the Government’s responses to three key parliamentary reviews: the Cooper review regarding superannuation, the Henry review regarding taxation and the Rippoll review regarding Financial Services. Significant changes look possible on a number of fronts and we will be reviewing them to understand any potential impacts on your investments.
In summary, we think you can move ahead with renewed optimism, tempered by a modicum of caution. The worst of the financial crisis seems to be history but it would be foolhardy to assume a complete absence of aftershocks.
