Dr Shane Oliver argues we should expect another year of reasonable returns, despite lurking risks.
A year ago it seemed everyone was obsessed with Europe. At the time we thought there was a case for a bit of cautious optimism and, as it happened, 2012 has turned out okay, providing solid returns for investors.
While sentiment is now not as bleak as last year, we remain cautiously optimistic for several reasons.
Firstly, the risks around Europe remain high but are receding. The European Central Bank’s funding intervention in banks, its threatened bond-buying program and the Eurozone’s ragged but seemingly dogged determination to head towards “more Europe, not less” suggests that the risk of a blow-up in Europe will continue to recede.
Secondly, the US should have a reasonable year in 2013 as the housing recovery adds around 0.75 per cent to growth, shale oil and gas continues to revolutionise the US, capital spending rebounds after the uncertainty associated with the fiscal cliff, and quantitative easing spurs growth.
Thirdly, China looks like it is on track for growth around 7.5 per cent at least, with the slowdown behind it. Growth in Asia, Brazil and India should also stabilise and begin to improve, following significant monetary easing.
Pulling all this together suggests:
- Global growth somewhere around 3.25 per cent in 2013, ranging from a mild but fading recession in the Eurozone, 2.5 per cent growth in the US, 5.5 per cent growth in the emerging world and 7.5 per cent growth in China;
- Benign inflation in response to 2012’s growth slowdown and spare global capacity;
- Continued low interest rates and quantitative easing leading to a very easy and growth-supportive monetary environment; and
- A stabilising, then improving earnings growth, reflecting the improving economic backdrop.
For Australia, growth is likely to remain subdued initially as mining slows and non-mining is slow to pick up. This is likely to see unemployment rise to around 6 per cent.
Against this backdrop the Reserve Bank of Australia is likely to cut rates further to 2.5 per cent in order to push bank lending rates down closer to past cyclical lows.
However, as the impact of rate cuts starts to feed through with normal lags, growth should start to improve by year end.
Overall we see growth around 2.5 per cent, but this is masking a second half upswing; inflation remaining benign; and the cash rate falling to around 2.5 per cent in the first half.
So what does this all mean for investors?
- Shares are likely to provide another solid year of returns. Shares are very cheap against bonds, as bond yields have fallen further and should benefit from ultra-easy monetary conditions globally and the anticipation of stronger profit growth in 2013-14. Worries about Italy and Spain could trigger a bout of volatility around February/March, but overall returns are likely to be solid. See Table 1.
- Falling interest rates and improved sentiment towards China are likely to see Australian shares do well, but uncertainties about the growth and profit outlook will act as constraints. We expect the Australian ASX 200 to rise to around 5,000 by end 2013. Bombed-out cyclicals such as resources, along with yield plays like telcos, are likely to outperform.
- The Australian dollar is likely to fall to around parity with the US dollar as the combination of a narrowing interest rate gap, slowing growth and a widening trade gap offset the impact of more US quantitative easing.
- Cash and hence term deposits are likely to become even less attractive as cash rates slide to 2.5 per cent, further pulling down term deposit rates well below 4 per cent.
- Historically low starting-point bond yields suggest low returns from sovereign bonds, unless global growth takes a renewed leg down. Australian bonds are a bit more attractive than global bonds, given higher yields. Corporate debt is a better bet for those after income.
- Property securities are likely to continue to benefit from investors seeking yield; however returns are likely to slow after the 20 to 30 per cent returns of 2012.
- Unlisted commercial property and infrastructure are likely to benefit from relatively attractive returns and strong investor demand, given their relatively attractive yields: eg, around 7 per cent for commercial property.
- Australian house prices are likely to see a modest 4-5 per cent bounce on the back of lower mortgage rates.
What are the risks?
The main risks relate to US budget and debt problems, a relapse in Europe, slower growth in Australia which could see the cash rate fall to 2 per cent and a sharp back-up in bond yields if investors get more confident.
Conclusion
While the year ahead is likely to see occasional bouts of volatility, returns overall are likely to be reasonable as global growth picks up a bit and monetary conditions remain ultra-easy globally and become increasingly so in Australia.
Dr Shane Oliver is head of investment strategy and chief economist at AMP Capital.
