KGB: Alan Oster & Tim Toohey (part 2)

The National Australia Bank and Goldman Sachs chief economists say the dollar's strength needs more consideration and Australia's transition from mining investment is short on support, while China sits at a turning point.

To read the first part of this interview, click here.

TT: Well, let’s put it this way to begin with. If you did a round-up of the data in China, the data’s actually based out probably five months ago. The financial markets got very excited over one trade report effectively which looked like a massive turnaround. But I’d say that at least 50 per cent of the economists out there discounted that for a number of reasons.

And if you sort of broke down the data at the moment, I would argue that 60 per cent of it is going up and 40 per cent of it is flat to going down. It’s including fixed asset investment and manufacturing, including, you know, elements of industrial profits. You know, there are elements of that Chinese data at the moment that are actually sort of weakening rather than accelerating. So, I wouldn't want to overramp the type of data that we’re seeing, particularly heading into Chinese New Year and coming off a restocking phase. We’re getting a little bit of perhaps overinterpretation of the Chinese data, in terms of the momentum, I think. That’s helping market sentiment and the like.

But the big issue, and I mentioned this at the start, is that most of the developing world and in particular in Asia, are very close to an output gap being zero. We’re seeing large increases in iron ore prices again and a few other commodities. Their own food prices, largely vegetable prices, but their own food prices are breaking out to the upside. They’ve got some inflation on their hands very, very early into recovery phase. That’s unusual, right. So, the idea that we’re going to see an extension of what we saw in the past for China – which was basically an extension of bank credit or bank balance sheets flooding into the economy and developing massive infrastructure investment – I think is behind us and I think what we’re seeing at the moment is, through the handover period, some additional liquidity to make sure things happen nice and smoothly. But don’t overstate the ability of the old model to continue to work as it has in the past and don’t understate the idea that they actually are pretty serious about moving out of productivity driven growth environment. You know the working age population is going negative and productivity growth at the moment of around 4 per cent doesn’t give you 8 per cent growth into perpetuity. So you need to be a little bit careful about how you view it going forward.

RG: It’s scary for our commodities, isn’t it?

TT: Not really. It’s slower growth off a much bigger phase, so it just means they’re changing the nature of their economy a little bit. So I think this is something that will temper investment growth here as people reassess just how long this goes on for and what the actual path is. But I do think it’s a different type of growth that we’ve got to get used to.

AO: You know, I was going to agree. I’d say it’s more that the fact that China, if you look at the data, the data says it’s at a turning point. It’s not saying it’s bounding back. It’s saying it’s at a turning point. I think the underlying natural rate in China is somewhere around 7, 7.5 per cent – somewhere in that area.

AK: And that’s a five-year plan.

AO: Well, yeah. But you can do 8 per cent in that if you fire it up a little bit. But you know, what scared the market last year was the fear that it was going to be sub five and therefore the commodity prices were going to crash and et cetera, et cetera. And then iron ore has come back, but I don’t see that as permanent. I see there’s an element of that of restocking in the lead-up to the Chinese New Year and I think if you look at the futures market, all of them have it at $120 or thereabouts. None of them have the current prices.

AK: So, by way of summarising this very interesting discussion – and you mightn’t want to do this – but is the bear market in equities over and are we now into a bull market? Or is the rally we’re seeing a bear market rally?

AO: I’m not an equity analyst, so…

AK: I know you’re not an equity analyst, but what do you think, Alan?

AO: I think we’re probably in a situation where you’ve had a correction from an overly negative equity market that will factor in the idea that Europe’s going to blow up and China’s going to have a hard landing and the US will never get over the fiscal cliff, into something that says now it’s going to grow at about 3 per cent. So I think there’s been a level adjustment. If I was looking forward, I don’t think this is going to continue at the sort of rates we’ve had.

I think we’re up 22 per cent or something in the last six months. My expectation I’m going on from now until the end of the year something like 10 per cent, so I sort of think we’ve had a correction back to average or below average growth. It’s less frightening, but there’ll still be bumps. You know, you only delayed the fiscal cliff for two months and you’ve still got the debt ceiling in the middle of the year, but those things can still cause you grief. And there are still the problems about Spain and Italy, particularly Spain. So you know – that Europe is fixed and don’t worry about it, to me the unemployment rates continue to go up, you’re going to have negative growth until the back end of this year. So I don’t see that as a reason to become really optimistic in terms of equity markets.

AK: Tim, bull or bear?

TT: No. Be bullish. And look, our target for this year is already within sight. You know, our target is 5000. It’s been 5000 for a little bit, but I think we can make the case as we move forward and if we do see what we think will happen with, you know, some of the negative things that have been holding back this economy, starting to get into the rear view mirror a little bit – some of the data starting to improve into the back half of this year – we can see the rally extend. I guess the one thing that I would suggest though is we need to be a little bit cautious about the pattern that we’ve seen in markets over the last four years. We start strong and we’ve been annualising anyway, since the last quarter of a century, 17 per cent annualised returns in Q1. We'd love to do that again, but the middle two quarters have been flat from an activity point of view globally, not just the US where it’s been uniform the last four years.

AK: It’s been every year for the four years, hasn’t it?

TT: Yeah. That’s right. And becoming strong again at the end of the year, and there are some reasons to believe we could do that again. Part of this is policy induced, part of it is weather induced. The pattern is something just to bear in mind at a point where the equity market is actually paying out for growth to a reasonable extent. We could say the multiples are around average levels now, so the market is no longer cheap. You can certainly say that. But there’s no reason to believe it won’t head further into the expensive territory, particularly when you look at the other available investment vehicles in front of you.

AK: Thanks very much, gentlemen.

AO: Thank you.

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