2012 Economic Overview
World share markets are currently on track to deliver double-digit returns for the year, which seems remarkable when you consider how dire much of the economic news was during the last 12 months.
Bond investors have enjoyed another solid year, with bond prices rising as bond yields in the major world markets kept falling. With historically low bond rates and cash rates around the world also very low (or zero, in some countries) investors searched desperately for decent sources of income. This benefited listed real estate, shares paying high dividends and corporate bonds, especially high yield bonds.
In a world short of AAA-rated government bonds with anything like decent yields, Australian government bonds, and therefore our dollar, were sought after.
Greece: a continuing problem
The year began fairly well, with share markets rallying strongly in the first three months. Much of the economic news around the world was surprisingly positive, particularly in the US. The European Central Bank (ECB) injected even more funds into the European banking system.
In Greece further debt-cutting measures, and a ‘voluntary’ restructuring of some privately-held government debt, reduced Greece’s outstanding public debt and allowed the Greek government to receive more cash from the International Monetary Fund, the ECB and the European Union.
The June quarter proved much tougher, with both Australian and global share markets losing ground. It became clear that Europe’s issues were far from resolved and that Greece’s debt restructuring hadn’t gone far enough. A substantial share of Greece’s debt is held by Europe’s banks, including the ECB. As they hadn’t participated in the debt restructure, the cut in Greece’s public debt burden was grossly inadequate.
Greece held an early general election and after two attempts to form a workable government, a coalition was finally formed in June. It agreed to implement the debt-reduction plans Greece had signed up to earlier.
Fears for Italy, Spain and the US
The financial markets soon had bigger worries than Greece.
With concerns growing about Italy’s ability to deal with its enormous public debt, Italian bond yields soared at times during the year.
In Spain, government borrowing costs also rose dramatically as markets focused on the likelihood that Spain’s banking system would need a bail-out, which would put more pressure on its public finances.
In the US, the economic news took a turn for the worse. This eventually raised hopes that the US Federal Reserve (the Fed) would come to the rescue again by printing more money (known as quantitative easing, or ‘QE3’). Markets actually began to react positively to disappointing US economic news, on the basis that it made QE3 more likely.
As it turned out, QE3 was announced in September, with the Fed deciding to purchase $40 billion in mortgage-backed securities every month, with no time limit.
ECB President Mario Draghi announced the ECB intended to buy unlimited amounts of bonds issued by any troubled eurozone government.
In the last few months, economic data has taken a turn for the better − particularly in the US, which clearly helped President Obama’s election prospects.
Avoiding the US ‘fiscal cliff’
In the wake of the US election, attention has quickly turned to fiscal policy and efforts to avoid the ‘fiscal cliff’. This arrangement was part of the resolution to last year’s budget impasse. Congress and the White House put in place a plan, due to take effect in 2013, to massively cut spending and increase taxes. They hoped that fear of the fiscal cliff would force both sides of politics to negotiate a credible deficit reduction deal.
However, a deal hasn’t been done. If the arrangement does become effective, there’s the risk of a renewed US recession.
To solve the problem, compromise and common sense are sorely needed. However, the sad reality of US (and indeed global) politics is that there’s no guarantee that common sense will prevail. There’s still a real possibility that the gridlock in US politics will persist.
Ups and downs for Australia’s economy
Our economy remains a mixed bag.
While economic growth rates accelerated in the 2011/12 financial year (growth for the 12 months to June was above trend at 3.7%), more recent data points to slower growth. Although there’s a good deal of mining-related investment activity in the pipeline, several project cancellations and postponements and the uncertain global outlook have cast doubt over the future strength of mining investment.
Consumers’ spending is increasing at a rate broadly in line with household income growth, and their confidence levels have started to improve. Housing activity is tentatively responding to lower interest rates. However, recent business surveys have been more subdued and the labour market has weakened a little. This softness in the labour market, along with global uncertainties and inflation that remains in check, enabled the Reserve Bank of Australia to reduce official interest rates twice in 2012. The cash rate is now at 3.00%, equal to the global financial crisis low of 3%.
The outlook
Stronger returns from shares are welcome relief for investors, who have endured the worst global financial crisis in over 80 years. Despite this, the outlook is very uncertain, as there are a range of paths the world economy and financial markets could take.
At this stage, the future return potential of Australian and global shares looks reasonable, especially as future returns from cash, term deposits and government bonds seem poor. However, markets are strongly influenced by policy-makers’ announcements, so there’s still the risk that shares will deliver another period of poor returns. We wish to think optimistically!
We thank Brian Parker, Investment Strategist MLC Investment Management for this review.