|Summary: A taper, in other words an easing back of the massive United States money printing economic stimulus program, sometime next year will likely have far-reaching consequences, including for the Australian stockmarket and our dollar. Among other things, Australia will also need to grapple with rising unemployment.|
|Key take-out: The level of the Australian sharemarket in the coming months will reflect speculation on the timing of the US tapering and the extent of looming local interest rate falls.|
|Key beneficiaries: General investors. Category: Economics and investment strategy.|
In my last Eureka commentary for 2013 I want to acknowledge first what a wonderful year it has been. But I have just farewelled my son and his family to Canada, where costs are lower and there is a more expansive mining industry. In addition, disappointed, I am watching the new Federal Government beginning to flounder.
So, as I look forward to 2014, I am going to make 12 predictions with an extra touch of nervousness about Australia. In the knowledge that I will make mistakes, I’ll follow these predictions at the end of March and in June to see how they are progressing.
I well understand that crystal ball gazing is extremely hazardous, but too many commentators write predictions that cover just about every possibility and become totally useless.
I am also aware that every year stockbrokers predict about a 10% to 15% rise in the market. Last year they were right (and conservative), but they have been wrong in previous years.
So here are my predictions for 2014.
1. I will come to the timing of this in the number three prediction, but let’s look at what I think will happen when the US tapers (that is, stops its money printing and bonds buying stimulus program). There is going to be a firming of the US dollar as American interest rates edge higher. Those higher US rates will disrupt the American housing market and American consumers. Globally, we have to hope that the big Wall Street banks and their hedge funds and other clients have had sufficient warning of the looming tapering so they are not caught too far out on a limb in speculative plays including buying high-yielding securities. My fear is that the excess of capital that has seeped into all areas of the world from the US will begin to return to America once interest rates rise. That will cause surprise repercussions. And, of course, that will have repercussions. ANZ Bank chief executive Mike Smith says that he believes people are underestimating what will take place once tapering gets into full swing.
Meanwhile, the higher US dollar will cause a fall in the Australian dollar. It will also mean a correction on Wall Street, which may have reached a peak for the time being. Both these events are already taking place, but in my view they have further to go. But the US economy is developing a head of steam, and the effects of the taper will pass. My prediction is, that leaving aside hedge fund style disasters, the end of the taper will see a US correction and then the beginning of a much stronger American economy. As a result, in 2014 use the taper to buy American and other good global shares. Australian investment companies like Templeton (where I have a holding) are the low fee way to go.
2. I am nervous about the emerging economies. Numerous brokers have recommend investing in them and they may be right, but I suspect a series of non-bank institutions have used the quantitative easing liquidity to go for high emerging yields and will not be able to extract their money without heavy loss. We saw the danger in the taper scare earlier this year, and this week Asian markets are down. I don’t think the taper-created money exodus problem is fixed---although no-one can be sure. Hence the high risk. Do not be over exposed in this area. Because of my age I am increasingly cautious and staying away, but that might be a wrong strategy.
3. When will the taper start? My guess – and it is a guess – is that it will start in the first half of calendar 2014. Already, unemployment in the US has moved down to 7% and that surely will trigger the beginning of tapering. It will probably be tentative at first. I know Mike Smith believes it will come at the end of the year, and he may be right, but my prediction is that it will happen in the first half. So be aware in all your dealings of the possibility of the effect of tapering being felt in the first six months of 2014.
4. I believe Europe will continue to muddle through, because the Germans will keep pumping their savings into propping up the European economies and the European banking system. The only way that could be wrong is if the German courts stop that process, and frankly I don’t think that is likely. The other danger is that too much of the US hedge fund money has filtered into European high-yielding bonds and, as it withdraws, great problems will arise that can’t be matched with the German savings. But, overall, I think Europe continues to muddle on with small amounts of growth but with continued enormous pain in Italy, Spain and France to keep this thing going. I think the UK is looking a lot stronger and is benefitting enormously in not being part of the Euro.
5. I am a China optimist. I think the new administration of China has taken full control and will attempt the process of moving the Chinese economy from simply an export/infrastructure structure to one where more consumers consume. But this will be a difficult process and from time to time they will revert back to their current strategies to avoid higher unemployment and the political consequences that go with that higher unemployment.
I think there will be a much greater emphasis on lower emissions. The pollution in China is extraordinarily bad, and in places like Shanghai and Beijing the Chinese must be afraid of the effect on their health and the health of their children.
And that apprehension will start at the very top of the Chinese administration, because everyone is being affected by it.
That means I am worried about demand for steaming coal, although I think that in other places like India it will become more widely used as a form of cheap power to underprivileged people. However, I think iron ore demand will hold. I expect Chinese investment in Australia to rise, particularly in property (see point 9).
6. In Australia we will see in the opening months of 2014 some rise in non-mining business investment as we catch up, but hanging over the Australian economy will be enormous unemployment boosts as we combine the fall in mining investment and the contraction of retail in second-grade shopping centres (partly caused by the rise in shift allowances and penalty rates on July 1, 2014). In addition, we have the cutbacks in public servant numbers. To those situations we will add the motor industry turmoil. I don’t think the Government will allow the whole motor industry to collapse, but I am not listing that as a prediction because it is simply chaotic in Canberra at present. It is a reminder of the Gillard/Rudd days. If we do completely dismember the motor industry, you are talking about between 350,000 and 500,000 jobs lost in those four movements – automotive, mining, retail and the public service. That will stifle development in Australia for the life of the current Abbott Government. And so the big stimulus it planned via infrastructure etc. will be partly nullified by these other enormous trends. Nevertheless, I believe in 2014 we will see the beginnings of more opportunities in infrastructure securities to offset the low deposit rates.
7. Banks have had a wonderful run. They are providing income for a large number of retirees who also now have large capital profits as a result of the rise in bank shares. I am not suggesting you sell out of banks, but I would be wary of investing a great deal more in them at current prices They could well rise in 2014 as interest rates are lowered, but in 2015 and 2016 when the sheer horror of the unemployment change becomes apparent, particularly if car manufacturing is shut down, it will make people nervous about bank bad debts. And, of course, it will hold back consumer expenditure and all the things that go with that.
Conversely, I am more bullish about our miners because they are now really beginning to manage their businesses properly. BHP in particular, but also Rio, are really getting into the cost-cutting business. Even in coal, the new BHP CEO Andrew McKenzie is talking about underground mining rather than open cut, but it will be far lower cost because of mechanisation. Because I think China demand will hold up, these cost-lowering exercises will be a real boost to our larger miners. And if I am right that the Australian dollar will fall, then miners look attractive – particularly if their shares fall in the overall decline that will come with tapering. Have some money on the sidelines ready for this.
8. Interest rates are not as a big an influence on the economy now as they were say a year ago, and basically represent an income transfer from savers to borrowers. I believe as the unemployment figures rise the Reserve Bank will lower interest rates, but not substantially because the end of US tapering should also help the Australian dollar fall further. I find bank deposit rates too low for my main superannuation fund, but if you are using bank deposits go into longer terms.
9. If you live in Sydney or Melbourne look at the cranes and realise that most of those cranes are being funded in part by Chinese capital, partly reflecting the pressure that the new leadership of China is putting on its people to invest more offshore but not through US treasuries. They are going to build Australian property and, in the process, they tend to push the prices higher. As they do young Australians will not be able to buy houses, and it will be left to our investors to keep Australian equity going. I suspect that during 2014 the self-managed fund ability to gear property investment will be moderated but not abolished.
10. The level of the Australian sharemarket in the coming months will reflect speculation on the timing of tapering and the extent of looming local interest rate falls. We will also participate in the Wall Street correction that will come with the taper, but as the year rolls on the rising Australian unemployment problem will become more apparent.
11. The Abbott Government will begin to understand the magnitude of the games it is playing in unemployment and will push for infrastructure investment like crazy. It will need to harness the superannuation movement to provide the capital. I think there are going to be opportunities for infrastructure investment that is partially guaranteed by the government – perhaps guaranteed income for a period, which will be very attractive given the low yields that are currently around. That emphasis on infrastructure securities will take some of the pressure off bank shares as the main source of income for self-managed superannuation funds that are in pension mode and need income.
12. Look for companies that understand the fact that we are moving into an era of data analytics. As I described last week (see Portfolio lessons in a changing world), Ian Tho of Azurium (Ferrier Hodgson’s management and development arm) tells us that we are going to gather data from many different sources so companies can predict demand and supply and adjust their strategies accordingly. This will be very profitable for those that do it well and mean that much less capital is invested. But the total scene and the increase in online retailing that is coming will make it tougher for retail shopping centres. The Westfield-Lowy money is moving away from the retail centres, or at least some of them. They clearly understand what is ahead.
In 2014 I will be looking for companies that have a touch of innovation in them that are not just sitting there running the same business, because you simply can’t do that in the next decade. Much of the profit growth will come out of cost reduction, and while that is good it’s innovation that leads you into a more sustainable situation. Some companies are far better at it than others.