KGB Interrogated

James Kirby quizzes Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz on what's in store for the markets and the economy in 2013.

Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz tell James Kirby:

Where they expect the Australian dollar and the official cash rate to go in the year ahead.

Whether they think the eurozone will be able to survive another year in its current form.

How the fiscal cliff drama will affect Australian markets.

What roles the end of Australia's investment boom and energy price fluctuations will play in the year ahead.

Their views on whether a federal surplus will come to pass.

* This interview was published prior to Wayne Swan's announcement that the federal government would be unlikely to achieve a budget surplus in 2013.

James Kirby: Hi, I’m James Kirby, managing editor of the AIBM, and I’m here today to talk to the KGB. It’s that time of the year when we talk to the KGB about the year ahead, 2013, and the outlook for what we can expect. Hi Alan, hi Steve, and hi, Bob.

Alan Kohler: G’day, James.

Robert Gottliebsen: Hi.

JK: Robert Gottliebsen is joining us remotely from his coastal location. Alan, let’s begin and talk about the big issues of the year – and I think we should start perhaps with some of the big themes. I suppose one of the outstanding issues that dictate our economy is the dollar and where it’s at. We’re sitting here today, it’s Christmas, and the dollar is at $US1.05; probably higher than many people thought it would be. And it shows little sign of dropping. Where do you think it’s going to go?

AK: Well, I don’t think it’s necessarily going to go down – and we would have been sitting here a year ago saying that the dollar was overvalued. Lots of people were saying that on a theoretical basis the dollar was and is overvalued. But that’s really irrelevant to what’s happening around the world which is that America, Europe, soon in Japan, and China, everyone else really are trying to depreciate their currencies and we are just caught really, particularly in America’s efforts to get the currency down. They’re printing dollars. They’ve got zero interest rates, have had for four years, and will have for longer. So I don’t think the dollar is going anywhere, but potentially, possibly up. And certainly not down.

JK: Okay. Robert Gottliebsen, linked with that is interest rates, and interest rates have come down considerably over the period of the last year. The issue now is, do they fall much further? And is it actually dangerous to cut much further from here? Because if inflation comes, if the economy picks up, the RBA could get it very wrong.

RG: Yes. And normally you probably wouldn’t cut interest rates, but we’re in a global war. We will have to cut the rates quite a lot. Our first home buyers have gone on strike in many areas and they’re not prepared to buy houses unless there the actual repayments are less than their rent. That particularly applies to apartments in Sydney and Melbourne. But we will cut the rates and that will engender speculative, investment buying of houses. It will actually engender some buying of property, it always does in Australia. But there are some clouds out there for us that we’ll need to sort out.

JK: Okay. Thank you, Bob. Well, let’s just pick up on that because what Bob’s alluding to obviously is, Steve, that as rates drop, people move into other investment areas. They’re looking for a return. They’re looking for yield in the market, for instance. The issue of course which obsessed people a year ago was about earnings. Will the earnings come through? Now, as we look at 2013 there is the issue of earnings, but there’s also the price put on those earnings. And it seems that maybe the market is reassessing the share market in that light. Do you think earnings will come through? And do you think they’ll be priced even stronger than they are?

Stephen Bartholomeusz: I’m not convinced earnings will come through and I’m not convinced that rate cuts are going to have any impact. The psychology of consumers and businesses is now so negative that nothing the Reserve Bank can do, or for that matter the government can do, that is going to change that quickly. It may be that an election some time later in 2013 will have an impact, because I think part of the issue here is the uncertainty generated by the politics and the kind of unusual parliament we’ve got. And so maybe the election will be the catalyst for a change in confidence. But at the moment everyone is so deeply risk averse, I'm not sure there’s anything anyone can do to actually change that quickly.

JK: Oh, let’sjust keep talking about the thematics for a minute before we talk about any specifics. Because of the things we worried about a year ago, some of them are still smack on the agenda, aren’t they, like Greece. Alan, even a year ago that we were talking about it, maybe even the year before. We’ve been obsessed, preoccupied with the European situation, typified I suppose by Greece because Greece is so bad; with 25 per cent unemployment, etc. Is it justifiable for Australians to be so preoccupied still with the Greek and European situation? Can the EU situation be contained?

AK: Look, it theoretically can be, but periodically various countries in Europe come to the fore as being the latest basket case. For a while it was Italy, then for a while it was France. The Economist had a big special on how France is heading for trouble. Spain is frequently being named as the next cab off the rank. I mean, all their bond yields are actually quite low at the moment, so for the moment a lot of those countries are okay. Greece is okay for a while. So, maybe Europe can muddle through for a while. But the key to it is getting a decent banking union and recently they’ve made good progress along that path with the kind of centralised banking system that they’ve started to have. And I think that, you know, they are doing the right thing. So look, it will be okay for a while, but it is hard to imagine Greece, for example, staying in the euro long term.

JK: Well, maybe that intensity of fear around Greece is softening outside of the EU.

AK: Well, it always softens for a while until the next need for a bailout and then it’s always worse next time. So look, I do think that the European problem is not over. They're slipping into recession. I mean I think they’re going to be in recession or depression for five years. So, I think that Europe as a whole is not going anywhere for quite a while. The question is whether there’s a major bank meltdown in Europe along the lines of what we saw in 2008 in America and so far, so good.

JK: Okay. Thanks, Alan. Robert Gottliebsen, what are you worried about for the year ahead? Obviously carbon tax was a big issue for you this year, though maybe to some extent that was a preoccupation as well, like Greece, because it didn’t really change the final outcome, certainly for the market or even the economy running at 3 per cent or so.

RG: I think the biggest thing initially in Australia – well, in the world – will be what happens in the US. I think that fiscal cliff will be more severe than the market is expecting and I think that’s quite nasty. It’s always possible there will be some sort of deal, but I doubt it.

The second thing is that after that will come this US energy boom. And there’s no doubt there are going to be substantial investments in the United States energy production by the shale oil and gas and that will start to lift the US economy, but in my view will cause a softness in energy prices going through in the next three or four years and that will affect Australia. And I think as far as Australia is concerned going to be one of the biggest issues.

Another issue is that the Queensland government is planning or is planning to take control of industrial relations in unincorporated bodies and that involves roughly 50 per cent of the workforce in that state. I think Victoria will follow and we’re going to see a totally different labour force situation in the two states, certainly Queensland, if that takes place. They're at the discussion stage. There'll be enormous debate; it will come through into the election debate of course because the Labor guys will say it’s back to WorkChoices in the states. But what that does is it really reinvigorates the majority of Australian employment. And it’s going to be a wonderful thing for those states if the Queenslanders have courage.

JK: Okay, thank you, Robert. Let’s pick up, Steve, on both those items. One is obviously less well known than the other. Let’s talk first of all about competitiveness in the oil situation and to what extent that hits our company earnings and company fortunes in the year ahead.

SB: I think the competitiveness issue is a huge one. If you look at what’s happened over the course of this year, we went from being, in the past, at the low end of the cost curve in resources – and resources is where all the action has been obviously in the last couple of years – to being in the upper 50 per cent of costs.

JK: And resources are really revealing that. Resources have been the worst case scenario for costs.

SB: So, the biggest thing that’s happened this year is that fundamentally the investment boom in resources has ended effectively. There are still projects being built, but very few new ones on the drawing boards. They’ve got mines closing and the like. And we are uncompetitive in a lot of the areas we used to pride ourselves on being very competitive.

That’s partly because of the IR environment and operating cost environments, partly because the capital costs of the projects have blown out so dramatically because of the competitive frenzy to get access to resources, and it’s partly because of the currency. But the currency is the biggest single influence on our competitiveness of our export industries relative to their competitors offshore. And there’s not much we can do about the currency. I think Alan was very right earlier when he said 'we’ve got to live with this'. And it’s partly fundamental and we actually do have a stronger reason for people to invest in our currency than in most that have been devalued continuously offshore. So, how we live with a high dollar and high costs and how we remain competitive, I think is the question we want the governments to play a role in answering.

JK: Okay. Well, let’s take up on that because that is really where we are. We know the investment boom is coming to an end. We know there are some pretty good basics: there’s the 3 per cent perhaps GDP perhaps, there’s 5 per cent unemployment. There are some fairly good basics across Australia. But we also know the investment boom – certainly the investment part of it, that is for the building and projects – that’s coming to an end. Alan, if we are to expect a year to look forward to in any way in 2013, where is the action going to come from if it isn’t going to come from resources? And Bob talked about the changing energy situation. Let’s have a look at that.

AK: I don’t really know where it’s going to come from. I think with the currency where it is, many parts of Australia – manufacturing, tourism, exporters – they’re in trouble.

JK: Well, just about energy prices. Before we talk about the other parts and because we are a resources economy, whatever part of the cycle we’re in, is it necessarily a one-way street that the US has lower energy prices. I mean, what about the Australian situation?

AK: Well, we’re world parity pricing. We’ve got all the gas and oil here, but we don’t get the benefit of it. And so, you know I think there’s going to continue to be pressure on the government to do something about that, but they probably won’t.They’re not going to reserve the gas for Australian industry and they’re not going to lower the pricing. So, you know, I do think that there’s a chance that the oil price will fall considerably next year. That’s one theme to watch for next year: a big fall, potentially, in the oil price – the global oil price – in which case gas and oil prices will come down and manufacturers will benefit from that. If Bob’s right and there’s going to be a big change to the IR landscape, the combination of low energy prices and improved IR situation will potentially revive lots of our industries.

JK: But Steve was quite cautious about the notion of earnings coming through in 2013. Where do you sit on that? And also, would earnings, even if they don’t come through the existing earnings, maybe be repriced? Because they’re being repriced in banks and financials.

AK: Well, to be honest it’s hard to see where the earnings are going to come from. I don’t think the banks are going to do much good in terms of earnings. I think retailers are going to struggle. I think manufacturers are struggling because of the dollar where it is. Tourism companies likewise. Media companies are all struggling. So look, if you go through the industries one by one, the one industry that might do okay next year is construction and building materials, because there continues to be a shortage of houses. Although it is true, as Bob says, that first homebuyers are on strike, there’s still a deficit of housing in relation to the population. So, we could see a bit of a recovery in the building sector next year.

JK: Well, we talk about what’s wrong and what we worry about. Let’s just for a second concentrate in the final part of this on what could go right in 2013. Because obviously, Robert Gottliebsen, the market surprised us this year. The ASX 200 so far is at 10 per cent or so with only a few trading days to go. The yields were roughly 4 per cent, put franking on top of that and people were bringing home 14 per cent returns on the ASX 200. The explanation is not as hearty as that; the explanation revolves around the banks doing so well. Where do you think we’ll go? And can the banks first of all return what they did last year? The Commonwealth Bank now is one of the biggest banks in the world and probably where part of the economy might shine. Bob?

RG: First of all, look let’s understand the impact of these lower rates on that equity market and the equity investments. Once upon a time your cost of capital was said to be 12 per cent and you had to get even higher rates than that to justify any investment. Now, the cost of capital of a big company is probably down around 7 per cent and they’re starting to recognise that. So they’re going to be looking at projects on a totally different basis. Certainly when you see earnings of a bank company or any company, you’re going to look at those earnings on a different basis because you’re looking at them in comparison with much lower interest rates. And it’s that difference that’s going to provide the activity.

People will say: "Oh I can buy XYZ company in a takeover situation and it makes sense to me because my capital is being priced on a wrong basis; my cost of capital is say 7 per cent. I can afford to do that." You’re already seeing in the property trust area people saying: "Ah, this company hasn’t being rerated for the new interest rates, I can buy it." And you saw GPT do that. There’s going to be more of that.

And so, in certain areas this lower interest rate situation is going to stimulate activity – simply because it’s a very big change. And it doesn’t necessarily mean that the place booms, but there’s a re-rating of equity situations. We're already seeing that. We’re seeing it now! I might add one more thing in Alan’s list of things that might go wrong. Government revenue is going to fall. And as it does, anyone who makes a big promise for the next election is telling a fib. They won’t have the money to do it.

JK: Okay. Thank you, Robert. And we might leave with one last issue which is the surplus. I just want to ask the three of you, sequentially, will they make a surplus? Robert, will they make a surplus in the budget this year?

RG: Oh, I think they’ll formally get there. They’ve got that huge telecommunications payment. They defer everything. But whether they do or they don’t, it’s done with mirrors and they’ll be pushing expenditure the next year to manage to do it. So, it’s somewhat academic.

JK: Thank you. Remarkable though that you think they'll do it. Though, Steve, do you think they’ll do it?

SB: No, I don’t think they will. I think they’re already trying to prepare the ground for an exit from the promise.

JK: Alan, you’ve been sceptical all the time. Could they actually still announce a surplus?

AK: Well, they could, but I think that Joel Fitzgibbon was given the job of flying the kite last week and, you know, I mean he was in my opinion not going rogue in saying that there shouldn’t be a deficit. I think… He’s the government whip. He was given the job of preparing us.

JK: Right.

AK: So, I think that that’s the case. The wild card for next year, if I can just throw something in, is going to be Japan. Following their election, they could actually introduce much more stimulus in their economy, joining the currency war to an extent that they haven’t before and you could see a massive rally in the Japanese stock market in 2013.

JK: Alright. That’s something perhaps to leave on a high note. And It would be nice to do that. Alan, Steve and Robert, thank you very much and thank you for watching.

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