Home' Australian Resources and Investment : September 2009 Contents AUSTRALIAN RESOURCES & INVESTMENT • SEPTEMBER 2009 • 15
RELUCTANCE BY HOUSEHOLDS TO TAKE ON MORE
DEBT, AND BY BANKS TO LEND, WILL PREVENT ANY
This is the most common worry. However, there are several points to
note. Firstly, consumers do appear to be responding to fiscal stimulus
and lower interest rates. This is certainly evident in Australia where
retail sales are up 7% year-on-year, car sales appear to have turned the
corner and various housing indicators have improved dramatically. These
trends suggest that consumers have not lost the inclination to consume.
In the US, retail sales have not collapsed, despite the rise in
unemployment, car sales are showing signs of recovering and consumer
sentiment has started to improve. While a more cautious attitude
towards debt will likely constrain the recovery in consumer spending, so
far there is nothing to suggest consumers are just focused on debt
Secondly, some indicators such as car sales and housing starts have
fallen below the level consistent with underlying demand, suggesting
that sooner or later there will be a spring back. In fact, the number of
US new houses for sale has collapsed and housing starts at record lows
may soon lead to a housing shortage if construction doesn t pick up
soon.The experience in the early 1990s indicates debt de-leveraging
won t necessarily stop a recovery---the fall in private debt in the US in
the early 1990s didn t prevent an economic and share market recovery.
In fact, private sector credit normally lags an economic recovery. This
was evident in Australia in the early 1990s.
THE BLOW-OUT IN BUDGET DEFICITS IS A MAJOR
Right now the increase in budget deficits globally is appropriate
because without it we would be having a worse recession. Also, this is
unlikely to be boosting interest rates yet, as higher public borrowing is
being offset by less private sector borrowing. So it is not a major issue
right now. That said, in several years time once recovery has occurred,
governments will have to unwind their borrowing and this could cause
increased economic volatility.
EASY MONEY MEANS THE US WILL BE THE NEXT
Many worry that quantitative monetary easing will create inflation. The
first point to note is comparisons with Zimbabwe are ridiculous---it got
250 million % inflation because it wiped out its productive potential
and the Government turned to printing money to finance spending and
pay public servants.
Simply put: no goods plus lots of money meant prices surged. Right
now the main concern in the US and elsewhere is actually deflation, as
the global recession is resulting in idle factories and rising
unemployment queues putting downwards pressure on prices.
In fact, consumer prices are already falling in the US, Japan and
Europe where inflation is below zero and in Australia inflation is just
2.1%. While narrow money supply measures have surged, this is because
central bank easing has boosted bank reserves. Only when this feeds
through to a broader increase in credit, and economic activity returns
to more normal levels, will inflation be a serious risk.
But given the amount of excess capacity that has to be worked off,
this is likely to be two or three years away at least. Once we get there,
the inflationary impact will depend on how quickly central banks soak
up the extra money, however that is an issue for several years down the
track.It is also doubtful independent inflation targeting central banks will
simply acquiesce to permitting higher inflation as a means to reduce
public debt burdens.
EXPECT A DOUBLE-DIP RECESSION
Worries about a double dip are common towards the end of most
recessions. This recession is no different. The main fear is that once the
policy stimulus wears off, growth will collapse anew. Our view is that it
is too early to talk about a double dip because we haven t emerged
from this recession yet.
And given the impact of fiscal stimulus still to occur, particularly
via infrastructure spending, and the likelihood that we will start to see
a housing recovery in both the US and Australia next year, a double dip
next year appears unlikely. That said, it is likely that the unwinding of
fiscal and monetary stimulus could result in a renewed weakness, but
this is several years away.
THE $US WILL CRASH, CREATING RENEWED
This one gets a go every time some government makes noises about
diversifying their reserves away from US dollars. However, while a
further improvement in global confidence may result in more downwards
pressure on the $US, a collapse is unlikely as the two most traded
alternatives (the Yen and Euro) are no more attractive and the Chinese
won t allow a sharp rise in the Renminbi.
DEMOGRAPHICS IS DESTINY
Using demographics to predict the sharemarket is back in the headlines,
following Harry Dent s latest book The Great Depression Ahead in which
he predicts, largely on the back of demographic trends based on the
number of people in the peak spending age of 45 to 49 in the economy,
America will enter a Great Depression in 2010 and shares will not
bottom until 2012. I have a lot of time for Harry Dent s work and he
made a great call in the early 1990s.
Demographics are also becoming a major constraint in western
countries. But there are dangers in relying on it too much to make
grand calls. First, the relationship between demographic variables and
share markets is very rough and encompasses only a few big 30 to 40
year swings. It has given a bad guide decade by decade. This can be
seen in the chart below which tracks the percentage of the Australian
population in the peak middle aged savings bracket versus the share
Secondly, the combination of having children later, living longer
and delaying retirement all mean the relationship between demographics
and economic and financial variables will change over time. Thirdly,
demographics indicated that US shares should have boomed over the
last decade. Harry Dent s book The Next Great Bubble Boom from three or
four years ago predicted that the Dow Jones will reach 40,000 by 2010.
But so far it has been a terrible decade (the Dow is now at 8500, or at
1998 levels). So with demographic theories having not worked so well
over the last decade there is a danger in relying on them too much for
the next decade in terms of making big calls on shares.
SHARES ARE NOW EXPENSIVE AFTER THEIR RALLY
Shares have had very strong gains from their March lows. Forward price
to earnings multiples (the ratio of share prices to year-ahead consensus
earnings expectations) have increased from around eight or nine times
at the March lows to now around 14 times for both global and
Australian shares. This is still below longer term averages around 15
times. In other words shares have gone from being very cheap at their
lows but they are still not expensive.
The worry list is long and mainstream global equity markets will likely
face a more volatile and constrained ride over the longer term. Shares
may also have a rougher ride through the traditionally weak September
quarter than was the case in the last quarter.
However, we think that many of the current worries doing the
rounds are overblown and are not enough to prevent solid gains in
shares over the year ahead. Shares are still cheap, they are attractive,
relative to low yielding cash and bonds, an economic recovery from
later this year is likely to underpin an eventual improvement in profits
and most investors are still underweight shares, so there is a lot of cash
sitting on the sidelines.
Dr Shane Oliver is head of investment strategy and chief
economist AMP Capital Investors
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