19 December 2008
As the financial crisis continues to wash through the real economies, the International Monetary Fund (IMF) and various Governments are scrambling to revise growth forecasts.
The IMF has now forecast world growth at 2.2 per cent in 2009, down 0.75 per cent from the World Economic Outlook in October. Australian growth forecasts hover around 1- 2 per cent and falling.
Thankfully, economic commentators and politicians have stopped comparing the GFC (the global financial crisis) - as it is called - to the Great Depression particularly because of the interventionist role of Governments. Many believe the policy of tax increases and credit freezes only prolonged the Great Depression.
The current GFC is being compared to the 1974 recession on some occasions, or the 1982 recession.
Much of the angst is due to asset price deflation in the US with the bursting of the housing bubble, and the onset of the credit crunch.
Comparisons are also being made to the Japanese economy in the late 1980s, which had the most severe asset price deflation since the war, suffering zero interest rates for many years as well as a sluggish economy.
AMP Capital Investors Head of Investment Strategy and Chief Economist Shane Oliver says Australian GDP growth in 2009 may fall to 0.7 per cent, which will be the weakest year since the 1990-91 recession.
"During the next 12 months, we will see a couple of quarters of negative growth and probably a mild recession. But we will do better that the US, Europe and Japan," he says.
Shane Oliver believes there will be higher unemployment rates.
He says, "The biggest risk to the Australian economy is high personal debt and house prices. If house prices slide too much, we risk entering a debt-deflation spiral where sliding house prices trigger further falls in spending, which in turn trigger further increases in unemployment, and further falls in house prices and so on."
Michael Karagiannis, Senior Asset Allocation Strategist at UBS Global Asset Management says the question is not whether the Australian economy slows, but whether it will enter a recession in 2009.
"At this stage, we think the two risk areas to watch are housing prices and consumer credit defaults."
With the rapid decline in economic activity, central banks around the globe are convinced there is a greater threat from falling prices and growth deflation. Add to this brew growing unemployment queues and falling consumer spending, and we have a recession. The issue is not whether a recession will occur but whether it's short and sharp or deep and protracted.
Shane Oliver says that unemployment rates rose by around 5 per cent in past recessions. By 2010, unemployment could be in the range of 7-9 per cent.
He says the major difference between now and the 1970s is falling commodity prices rather than increasing ones - stagflation, whereas this time it's more deflationary.
BlackRock equities specialist James Holt comments that Australia is "doing better than the rest of the world" - cold comfort to most Australians given that a mild recession is our base case.
But not all experts are gloomy about the global economic situation.
Associate Professor of Finance from Melbourne University Kim Sawyer says there has been excess trading in pessimism.
"But while the contraction (in the US economy) may be sizable, it may also be short. I then expect a tangible bounce in the first half of 2009 both in terms of equities and the real economy. This will spill over to Australia", he says.
AMP Capital Investor's Shane Oliver believes the market will anticipate better economic news with stimulus packages beginning to bite in the second half of 2009 and 2010.
Associate Professor Sawyer says both the oil price shock of mid 2008, and the credit shocks of September and October have been priced out relatively quickly. There was more restructuring of bad debt in September and October than in any period in recent history.
The RBA as other central banks have done will cut the cash rate, which is expected to fall dramatically in order to kick start consumer spending and economic growth.
Will Australia be insulated?
As Australia's long term economic health is tied to China, Japan and the emerging markets, their prosperity is also ours to share.
With the recent announcement of China's 4 trillion yuan or around A$872 billion stimulus of their economy to fund construction over the next two years, Australia is poised to reap some of the benefits.
But some commentators argue the Chinese Government stimulus package is not all-new money, with much of it already in the pipeline and allocated to projects. With industrial production slowing in China, the outlook for Australian companies is still uncertain.
IMF and other economic experts have been calling lower growth rates in China for the past six months or more.
Michael Karagiannis Senior Asset Allocation Strategist at UBS Global Asset management also believes that growth in China will slow to around 7 per cent, well below the high double-digit growth figures of the past years.
Be greedy - when others are fearful
According to BlackRock's James Holt judging the bottom of the market really depends on the extent and timing of the recession itself.
"Equities markets tend to bottom around 3-6 months before a recession ends. So if you're waiting for the recession to end before safely getting back into markets, note that you'll have probably missed the boat".
"For example," he says, 'if we experience a recession in the last quarter of this year, and the first half of 2009, then it is possible that equities markets will bottom in the first quarter. But if the recession stretches right through 2009, the markets may not bottom until later in 2009'."
AMP Capital Investors Shane Oliver expects shares and LPTs will do better in 2009. Oliver says he is leaning towards Asian share markets rebounding, with investment grade credit debt enjoying its highest credit spreads since the 1930s depression, and may do better than equities over the longer term because of the high yields.
James Holt says interest rates are likely to remain low throughout 2009. Whilst government bonds are already quite expensive, corporate bonds are trading at some of the lowest levels since the Great Depression and may experience some better returns in 2009 as credit markets begin to normalise. Then equities are likely to follow suit.
Shane Oliver says, "International LPTs will also do alright but the model is under pressure due to the need to reduce debt, with more capital raisings."
He says Government bonds will do well with yields of around 4 per cent - but grossed up at 9 per cent total returns as yields fall - look safe bets".
Oliver says cash has been king for a long period but cash rates will come down close to 3 per cent - and will stay at this rate for a long-time. While housing rents are going up in Australia, yields on Australian housing are close to 3.5 cent, and 5 per cent on units compared to the US, where they are around 7 per cent on housing.
James Holt says recently Warren Buffett wrote that he was primarily guided by a philosophy of "being fearful when others are greedy and greedy when others are fearful".
"Now that investors are fearful and equity prices have dropped to historical lows, he has become very greedy again!"
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