World economy and investment outlook

Published January 21, 2012

By SHANE OLIVER
AMP CAPITAL INVESTORS


THE latest rating downgrades to various countries in Europe and its bailout fund itself are a reminder the European crisis is continuing. However, the downgrades tell us nothing new - indeed European shares actually rallied after the news. Moreover, I was determined after writing endlessly about Europe last year that my first note this year would not be on Europe.


In fact, this note takes a different tack to normal Oliver's Insights. Having just gone through a time of lists for Christmas presents and New Year resolutions, I thought it would be useful to provide a summary of key views on the global economy and investment outlook in simple point form, both from a 2012 and a medium-term perspective. In other words, a list of lists. So here goes.

Key themes for 2012

Fiscal austerity and deleveraging in Europe and the US.


Monetary reflation with quantitative easing in Europe, the US, the UK and Japan, and rate cuts in the emerging world and Australia.


The emerging world to again account for most global growth.


Global growth of 3 per cent, 1 per cent in advanced countries, 5 per cent in emerging countries and 3 per cent growth in Australia.


Falling inflation and price deflation in some areas, thanks to plenty of spare capacity.


A volatile first few months in markets on continuing European woes, but then improving market conditions and returns as markets start to anticipate the next economic upswing helped by attractive valuations and easy monetary conditions.

Key risks for 2012

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 expanded unemployment benefits.


China eases too late to prevent a property crash and hard landing in growth.


Tension regarding Iran leads to a growth-threatening surge in oil prices.

Four (or five) key indicators to watch

The spread to German bond yields for Italy, Spain and France - a further narrowing would be a good sign.


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 as turn-downs in mid-2010 and mid-2011 both inspired false 'double dip' alarms.


The A$ is a good indicator of global growth - if it stays up things are okay. So far so good.


... and Dec 21 when the Mayan calendar apparently ends, although as far as disaster movies go, 2012 was rubbish compared to Towering Inferno!

Five reasons why the emerging world is in reasonably good shape

Low public and private debt levels.


Low per capita income levels = huge potential for further catch-up 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 if the world does go into recession it would be unlikely in Australia

Long way to go to zero for interest rates. Roughly 85 per cent of mortgages are variable-rate and hence households get a huge boost to spending power as rates fall.


Low public debt by global standards means scope for fiscal stimulus if necessary.


The A$ will fall if need be, providing a buffer.


Corporates 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.

Four reasons why the Australian dollar is likely to remain strong on a medium-term view

Commodity prices are likely to remain in a long-term uptrend on the back of emerging world industrialisation.


Australian interest rates are likely to remain well above US, EU and Japanese interest rates.


Quantitative easing will increase the supply of US dollars, euros, pounds and yen relative to the supply of Australian dollars.


Safe haven buying of Australian bonds as it's one of only a few countries with a 'stable' AAA credit rating. The others are Denmark, Norway, Sweden, Switzerland, UK, Canada, Liechtenstein, Singapore, Hong Kong and Germany (for now anyway).

Why medium-term (5-10 year) economic growth in advanced countries and investment returns will be constrained and volatile

Private-sector deleveraging in advanced countries has a way to go, which will be a headwind for growth.


Excessive public-sector debt levels in Europe, the US and Japan and ongoing fiscal austerity.


Extreme monetary policy settings, eg, zero interest rates and quantitative easing, can inspire extreme market volatility when changes occur.


The easy gains from 1980s and 1990s disinflation are over, and deflation or rising inflation would be bad for shares.


Social unrest is on the rise and politics is becoming more polarised.


The policy pendulum is swinging back to the left with less growth friendly policies (tax the rich, re-regulate markets, trade barriers, etc) after the economic rationalism of Thatcher, Reagan and Hawke/Keating.


Greater reliance for global growth on emerging countries which are usually more volatile.

What should investors consider in the current environment (partly inspired by my friend Dr Don Stammer)?

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 timeframes.


Buy low and sell high - starting point valuations matter. And the lower valuations thrown up by market weakness over recent years provide opportunities for far-sighted investors.


Focus on investments providing decent and sustainable cash flows - dividends, distributions, rents - as they are a good guide to future returns, a good buffer in volatile times and provide good 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 the crowd got it wrong piling into the 'Japanese miracle' in 1989 (with Japanese shares falling 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 turned into the tech wreck of 2000-03), the credit and US housing booms of mid last decade (which turned into the GFC), it might also find that the dash for cash of the last few years will ultimately prove to be wrong over the next five years or so.


The writer is head of Investment Strategy and chief economist at AMP Capital Investors