Five key economic forecasts you should know

The consensus view on our economy is benign … and some forecasts could create a perfect environment for investors.

Summary: Economists are never in complete agreement, but the consensus outlook on the economy is fairly benign. This includes a view that economic growth will be around the trend level, inflation and rates will remain low, and that the dollar will depreciate.
Key take-out: If all the economic boxes are ticked this would be the perfect environment for equity investors.
Key beneficiaries: General investors. Category: Economics and investment strategy.

While I would never advocate basing an investment decision solely on what the ‘consensus’ expects, or forecasts, neither does it pay to ignore that view.

At the very least investors should use the consensus view as a benchmark – to test their own views, look for weaknesses and perhaps even investing opportunities.  It’s reasonable to expect market pricing to fully reflect consensus analyst views. It’s with that in mind that I’ll take a look at just what the consensus expects this week – focusing on the five key economic variables of relevance to investors.

Gross Domestic Product (GDP) or economic growth:

Most forecasters are actually fairly closely aligned here. There is an almost unanimous expectation that growth will be slightly below trend over the next two years. Trend is about 3.2% by the way and most are looking for something like 3%.  The Commonwealth Treasury is probably on the more pessimistic side for 2014-15 with its expectation of 2.5% growth, although it expects that to rise to 3% in 2015-16. The Reserve Bank (RBA) gives a range (2.25%-3.25%), with growth expected to be below trend or at trend this year, and anywhere from below trend to well above the year after that (2.5-4%).  While the consensus is around 3%, I think the RBA’s forecast probably captures best how the consensus actually thinks. Anything could happen! Any difference on the spectrum would likely reflect the ability of the non-mining economy to rebalance – or so the consensus view would hold. If it fails to rebalance, then growth would be around the 2% mark. If it does rebalance, then 4% is very probable.

Inflation:

Most forecasters expect inflation to remain below the target rate, in line with official forecasts. In terms of variation, there is maybe 0.5% or so in it. That is, on the low side forecasters think inflation will be around 2.5% for the next two years and then 3% is the topside. Either way, within target and fairly benign.  On the latest data, consumer prices are up around 3% annually, so in effect  forecasters are saying that momentum will be little changed. A bit of inflation is actually a good thing for earnings by the way, so a number at the higher end would be a plus for the equity market overall. More pricing power for listed companies in a higher inflationary environment etc. The positive side is that if this profile is met, the RBA is unlikely to be too concerned about inflation if it turns out to be stable at the top end.

The Australian Dollar:

Of all the economic or financial variables this one is the hardest to predict. Forecasting exchange rates is a mug’s game, as they say – which of course is why it’s left to economists! Now most forecasters do expect a sharp decline in the currency to something between US85 and US90 cents this year and US80-85 cents next. Having said that, a forecast of US90 cents at the end of both 2014 and 2015 isn’t all that uncommon either.  So a weaker $A is the consensus clearly, with the magnitude the only sticking point. That would be consistent with the RBA governor’s view that we should look for a sharp drop in the value of the Australian dollar over time. Much will depend on what the US Federal Reserve does, however.

Interest rates:

The RBA isn’t expected to hike the cash rate until the June quarter 2015, according to a Bloomberg survey of 31 financial market economists. Even then, it’s only a slim majority that expect that! That forecast changes by the end of 2015, with 77% of economist’s surveyed looking for a hike. Don’t be concerned by this however, as the median forecast is that the cash rate will only be at 3.25% by the end of 2015. Even the most hawkish (aggressive on rate hikes) of analysts only expects the cash rate at 3.75%. Assuming all of that is passed on to lending and deposit rates, that suggests a discounted variable home lending rate of only 5.85% at the end of 2015, a three-year fixed rate of maybe 5.95% and term deposit rates between 3-4.3%. In the interim, only two analysts look for a rate cut (another ¼%). Futures pricing in contrast (30 day cash rate futures) suggests a 50% chance of a rate cut by the end of the year.

Company earnings:

Over the next two years company earnings are expected post decent gains averaging 9% over that period. This reflects an expectation for growth of 6.8% over the next year, rising to 10.3% the year after.

Tying it all up, the consensus view is actually fairly benign. We’re looking at trend growth, a nonthreatening inflation rate around the top of the target – the best outcome for corporates as this is unlikely to provoke an aggressive policy response.

The currency is expected to depreciate, which of course is positive for those stocks with significant foreign earnings, while interest rates are expected to remain extremely low. If achieved this is the perfect environment for equity investors. Not too hot, not too cold with a very low interest rate environment to remain.