|Summary: The conditions are ripe for further good growth in Australia, and the equities market will record further gains. But other market areas will be less robust, and they should be avoided.|
|Key take-out: The Australian sharemarket will likely outperform global benchmarks, and further 20-30% gains are likely.|
|Key beneficiaries: General investors. Category: Economics and investment strategy.|
We start 2014 with the most benign economic backdrop and outlook in about seven years. Things look pretty good right now for investors, and the seas are the calmest they’ve been in a long while.
It’s been a consistent feature for each of the last five years that each successive year has been less volatile than the one before. This isn’t great for traders, or investment banks, but it’s fantastic for investors.
Last week, in The perfect scenario, I set the context for Australia, and today I make my calls for 2014.
1. Global equities to surge again in 2014.
Global equities will have another very good year of double-digit gains. Now is not the time to be overweight cash. How far into the double digits? Well, that’d be a guess at best. Suffice to say that I think the macroeconomic settings are aligned for gains in the 10-20% range for global equities generally, noting that major global indices in the US and Europe were up between 20 and 30% last year. We shouldn’t be scared off by those strong gains last year though. Multi-year double-digit growth rates are not unusual and for the US, the S&P 500 has experienced consecutive double-digit growth rates in 2009-10 and 2012-13. In the Australian context, the All Ords experienced growth (on an accumulation basis) of nearly 20% last year after a 19% gain the year before. The years 2003 to 2007 also saw consecutive double-digit growth rates of about 16% to 28% per year.
The risks to that forecast range are to the upside at this stage, given the benign economic backdrop and still ultra-low interest rate environment. The hunt for yield will likely accelerate given the apparent lift in global economic momentum and the resultant lift in confidence. The biggest threat to that view actually comes from policymakers – that is, some manufactured fiscal crisis in the US or in Europe. But most of the panics since the GFC have been policy related – even the European debt crisis, which was really just a market driven liquidity panic, was spurred on by policymakers.
I actually think the key area of uncertainty is the Australian market. Why? Because there is more debate – a wider variety of views on Australia ( and ongoing concerns over China). This means that the scope for surprise is greatest here I think, although I think the scope for surprise is very much skewed to the upside. It’s a risk-reward thing where you get higher returns for taking on higher risk, or so the theory goes. Although in our context, the risks are overstated.
As I highlighted last week, the consensus is that the Australian economy will underperform global peers and record sub-trend growth. There is a universal expectation of softness. At the same time though, recent partial indicators suggest the economy is growing well above trend. More to the point, we also have interest rates at record lows, the lowest debt servicing in about a decade or more, a low unemployment rate, high savings etc – not structural imbalances. This is not a recipe for ongoing weak growth.
We can’t forget that Australia has only ever had a downturn following a policy response to some excess – e.g. housing investment. And there is no structural reason for that now. It’s not like Australian consumers are heavily indebted. Nor is there any practical reason why Australia’s non-mining business is failing to invest for the future – only fear and uncertainty.
Otherwise the Australian economy finds itself in a very strong position, and the way I see things there is only one reason – and one reason only – that growth won’t be strong in 2014. That’s confidence, or rather the lack of it.
So with that in mind, and on the premise that confidence continues to improve (and I think with the global economy accelerating and given an absence of any crisis for the first time in seven years, this is more likely), I think domestic investors should prepare themselves for better times.
2. Steer clear of cash.
With the official cash rate at 2.5%, and likely to stay there for some time, investors should expect that any money left in savings or term deposit accounts will fetch very mediocre returns. Indeed, with many savings accounts paying in the vicinity of 1% from the banks, there’s no incentive to keep your money there at all other than having a guarantee on your funds should one of the major lenders get into serious financial trouble. But that’s not going to happen. There are some expectations that interest rates will start to rise, possibly later this year. Yet, even if that happens, any upward move will be very gradual – and the banks won’t be rushing to up their deposit interest rates when they’re sitting on billions of dollars of virtually free funding courtesy of ordinary accountholders.
3. The Australian economy surprises on the upside.
This is what the partial indicators (notwithstanding the recent jobs report which is a lagging indicators) are already telling us. Instead of growth being sub-trend it is more likely growth will be well above.
4. The Australian sharemarket will likely outperform global benchmarks – further 20-30% gains are likely.
Resources and banks make up the bulk (half) of the Australian market. Resource earnings will be bolstered by a lift in global growth, record production in 2014, and a weaker $A. As for banks, the credit cycle is lifting from recessionary territory, bank earnings will accelerate. Other sectors, industrials and consumer stocks will benefit from the acceleration in economic activity and nervousness over records set by US and European benchmarks. The All Ords in contrast is still about 20% below its peak level of 6,828 in November 2007.
5. The Australian dollar ends 2014 around the mid-90s.
My base case scenario is that 2014 will be a year of two halves for the $A. In the first half, the $A will likely weaken from current levels, but not by much ($US0.85-0.87), as the Federal Reserve Bank tapers its QE program. I think the turn will come though as much of the current weakness in the $A is predicated on the view of sub-trend Aussie growth – not just the taper. By the second half of the year, as confidence slowly lifts, I suspect it will be clear that the economy isn’t sub-trend and the $A will appreciate back to fair value (around the mid 90s) as a result.
That doesn’t mean I think the global economy is completely devoid of risk or eventful scenarios. There are two in particular that I am watching closely. The problem is, both are subject to extreme political or regulatory risk. That is, the outcome depends entirely on the decisions that regulators, or the Fed makes. This is not a market call and there is no way of forecasting that. In the interim, my call is for investors to stay clear of both government bonds and commodities for the time being.
6. Steer clear of commodities.
For now the fundamental support is there for a strong rally in commodities, but regulatory interest is keeping things in check here. If regulators drop the ball, or the market finds a way around it, commodities would rise sharply.
7. Steer clear of governments bonds.
This is in my not likely, but is still a highly probable scenario. I say that because, if it looks like bond yields are going to surge, the Fed and other central banks will simply crank up the printing presses or, in the Fed’s case, slow the pace of tapering and ramp up the negative economic rhetoric.
All in all, 2014 promises to be another great year for investors with the information we have at hand now.
I think Australia is going to be one of the outperforming markets this year though, if the lift in confidence that we’re seeing now is sustained. There is certainly no reason why it shouldn’t.
* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.