Keeping up with the resources boom

A few months ago the general assumption was that the global economy would recover in 2010, but it would be 'U-shaped'. That is, the upturn would be slow, gradual or measured – there are various ways to express it, but a quick return to health wasn't on the agenda.

But analysts are quickly revising that view. Some parts of the world – especially Asia – are experiencing 'V-shaped' recoveries. Of course that just leads the more gloomy economists to pronounce that the recoveries aren't 'V-shaped', rather the start of 'W-shaped' recoveries. That is, the upturn will be short-lived; disappointment will follow in the form of another downturn.

There is no doubt that the US economy is at risk of a 'W-shaped' recovery. Europe and Japan are also at risk, especially as population growth is flat or negative in many countries and Chinese and Indian industrialisation doesn't confer the same benefits as for other parts of the world, such as Asia and Latin America.

In Australia, the shape of recovery is expected to be 'U-shaped' to begin with, turning more into a 'J-shaped' expansion as the full benefits of Chinese and Indian industrialisation become realised.

One issue that goes hand in hand with the shape of economic recovery is the timing and speed of the withdrawal of economic stimulus. If central banks act too quickly in lifting rates, 'V-shaped' recoveries can quickly turn into 'W-shaped' economic growth paths.

So what does this mean? Basically, US sharemarkets have more consolidation work ahead. Over 2010 sharemarkets are likely to experience periodic surges followed by periods of consolidation – more like two steps forward, two steps sideways.

Commodity boom

If we're right with our view that China and India will continue to expand solidly in 2010, then this will translate into a pick-up in demand for commodities. Importantly it's not just the expansion in China and India but also solid growth rates for economies across Asia and the commensurate expansion of the middle class and demand for consumer durables.

The key question is whether commodity supply can keep pace with demand. In 2006 and 2007 the scale of Asian expansion caught central banks and mining companies alike by surprise. The same could happen again – especially given that the GFC caused mining and energy companies to mothball facilities or curtail expansion plans.

A sharp lift in commodity prices, or even a new boom, would lead to higher investment in the resources sector and greater demand for engineering services; the other risks include a revival of inflation and further appreciation of the Australian dollar. The real risk for Australian companies is that the Australian dollar holds above 80 US cents or 85 US cents rather than returns to the long-term average of 72 US cents.

Housing cost & supply

Just how tight is the housing market? Over the last year Australia's population rose by 440,000 people – the biggest increase on record and the largest percentage increase in 40 years. The number of migrants increased by more than 285,000 people. But dwelling commencements only rose by just over 131,000. On this basis you would have expected more people to be on the streets and for the rental vacancy rate to approach zero. But it didn't happen. In fact some Sydney landlords complained that they had to reduce rents or offer rent incentives.

CommSec found that Australia is building the biggest homes in the world, but at the same time there is new evidence that household size is increasing for the first time in at least a century, or perhaps since European settlement.

The debate about housing costs and supply will go on in 2010. There is no doubt that rising housing costs are causing children to stay longer with parents and for more young people to share accommodation. State and territory governments have to pay more attention to produce more land, reduce costs for developers and revisit zoning laws.

CommSec expects home prices to rise by 8-10 per cent over 2010. Population continues to grow and not enough homes are being built. For investors, rising rents and home prices is an attractive combination.

What's out for 2010

Recessions have already ended in a number of major economies and we expect more countries to emerge from intensive care and move into the recovery ward in 2010. As we noted above, the path of recovery will be uneven – with emerging nations in Asia and Latin America offering best prospects.

With the GFC receding into the background, investors will have less need to be pre-occupied with all things US. The US really did dominate attention in 2009, its financial crisis spreading across the globe, causing sharemarkets to move in lock step with the US Dow Jones and S&P 500 indexes. Now investors can pay more attention to what's happening in their own backyards. As a result the tight correlations that existed between major share indexes and US share gauges should ease markedly.

While the correlation ratio between the All Ordinaries and US Dow Jones was regularly near 0.95 in 2009 (where a perfect relationship would equal 1.0) it's important to remember that back in 2005 that ratio was around 0.50.

With recessions ending and recoveries taking hold, clearly there will be fewer references to rate cuts or super-low interest rates. But here is where it becomes interesting – central banks must gradually lift interest rates and sell assets without derailing fledgling recoveries. Clearly the process is not without significant risks.

Arguably more settled financial markets might lead to less volatility. But clearly this can't be predicted with any great certainty. All it needs is something new from left field such a new geopolitical crisis and volatility will return with a vengeance. Still, there has already been a sharp drop in the number of days that the All Ordinaries rises or falls by more than 1 per cent.