The perfect scenario
Summary: The economic year is already off to a good start, and investors can look forward to another year of above-trend global growth. While many analysts suggest the Australian economy may underperform, the leading indicators to date suggest this forecast is already wrong. |
Key take-out: The combination of strong economic growth and ultra-low interest rates mean it is still unlikely we will see inflation surge in the short term. |
Key beneficiaries: General investors. Category: Economics and investment strategy. |
I don’t think it’s unreasonable to state, at the outset, that 2014 presents one of the most benign global outlooks for investors in about seven years.
That’s obviously with the information we have at hand now, and we can’t ignore the usual caveats about the “unknown unknowns” – so-called acts of God, war etc. In fact, one of the more unusual features of the year so far is just how happy everyone is (cautious optimism). There is almost a unanimous agreement that this year should be a better year, which is in stark contrast to where we’ve been at the same point in each of the last five years. Not that 2013 was bad mind you, and for equity and property investors it was a great year. But the economic tone is certainly more upbeat now.
Some facts – here’s what we know
I want to start off by taking a look at what policy makers, and financial market economists – who rarely, if ever, differ, think of 2014 and match it to what we know.
2013 ended with news that the US economy expanded at a 4.1% clip (Q3 data) – the fastest pace in about two years. Similarly, growth in the UK has averaged 0.7% for the last three quarters (and is at 1.9% annually), which is the best growth since the GFC ended. Indeed, just this week we learned that one of the troubled economies – Spain – has posted the best growth in six years. It would seem then that with the data we have at hand, the rising optimism does not appear to be misplaced.
Trying to put this all into some sort of context, the boffins at the International Monetary Fund reckon that growth in the global economy this year will accelerate sharply from 2013 (2.9% to about 3.6%), and they recently announced that forecast was set to be revised up (probably to something more like 3.8%). Yet, even without an upgrade, that 3.6% growth outcome would be the best outcome since 2011. For practical purposes, what this means is that global growth is going to be above trend again in 2014. In fact, since the GFC the global economy has being running at an above-average pace of almost 4%. Take a look at chart 1 below.
What about the risks?
The truth is, I see very few real headwinds to global growth – that is structural headwinds. The imbalances and policy settings that plunged the world into the GFC are gone – well the structural imbalances (excess housing stock) are. And putting aside the rhetoric, the fact is the GFC is well and truly over. Government debt levels remain high in some economies, but these are manageable (outside of Japan) and unthreatening. Indeed, the global economy is in its fifth year of an above-trend expansion phase. At the same time, cash rates in the major developed economies are at 0% – money is effectively free for the major global banks, and central banks have said that policy settings will remain ultra-low for years to come. Most of them print money in one form or another, although it is important to note that the above-trend global expansion is in no way reliant on these ultra-low rates or money printing (yet that is the common misperception). In any case, rates aren’t going anywhere, so my point is that I see little that will disrupt growth in 2014. No structural imbalances and no policy responses. If markets can remain rational, things will be good – although we can’t forget the disruptions caused by the European debt hysteria in previous years. Markets could panic over anything, truth be told.
Similarly, I’m not concerned about the latest growing fad – concerns over secular stagnation. I wrote about this last year (Is Europe becoming stagnant?), but in brief it’s not a thesis I think is credible. Larry Summers (a professor of economics at Harvard and US policy expert) is right in some respects – excess aggregate demand was not an issue in the build-up to the GFC. This is something I wrote about frequently at the time. That doesn’t mean, as Summer’s argues, that growth was weak. Growth was solid and investors should ignore attempts at redefining solid growth outcomes as weak. We‘re seeing a lot of this at the moment given it’s politically expedient – it provides a framework for the maintenance of ultra-low rates.
Noting this strong growth, ultra-low rates combination, it is still unlikely that we will see inflation surge in the short term. Another implication of the Larry Summers secular stagnation theory is that strong growth was not the cause of the inflation pulse that we saw in 2007-08. This is something else I agree with, as excess demand didn’t cause inflation. Commodity prices remain in check following the significant regulatory focus on this market. So I don’t view inflation as a near-term threat, and indeed the focus is still on disinflation and deflation. Although here too I see no threat. It’s almost the perfect scenario for investors – strong growth and low inflation.
Australia expected to post below trend growth
While there is general agreement on what the global economic backdrop looks like, there is less agreement on the Australian economy – which is unfortunate given we live here! And that of course makes our investment decisions more difficult, and the landscape much harder to navigate. For what it’s worth, official forecasts from the Reserve Bank suggest that growth will be below trend in 2014 at around 2-3% – and naturally this is the consensus.
As to why growth is expected to remain soft? Well the mining boom was declared over in 2012, and while almost two years on this hasn’t occurred policy makers and the consensus of financial market economists remain adamant that 2014 will be the year. At the same time, consumer spending is forecast to remain below trend, non-mining investment at recessionary levels, while housing investment is only forecast to pick up slightly.
But how does that fit in with what we know? Not very well, to be honest, as this isn’t what the data is showing us. Fortunately then, that forecast is not tracking very well as we enter 2014. Why? Well, as mentioned, the mining boom hasn’t ended – the investment boom continues and the export boom has only just started. Similarly, and more importantly, recent indicators suggest that consumer spending is picking up and we know that the housing market has rebounded. Take a look at charts 2 and 3.
The above chart shows that the rebound in consumer spending has been truly remarkable. Having slumped since the middle of 2012 when the RBA slashed rates, spending has surged and we now find momentum at its strongest since 2009 (using an annualised three-month moving average of recent outcomes) .
Similarly, momentum on the lending front is at a four-year high – lending growth is surging, driven by owner occupiers and investors.
The bottom line is that the macro environment looks highly likely to provide significant support to investment markets in 2014.
For the first time since the GFC, markets have started the year not fretting over something – there is no sense of crisis. Moreover, recent global indicators suggest economic growth will be the strongest since 2011 and above trend. While many analysts suggest the Australian economy may underperform with below-trend growth, the leading indicators to date suggest this forecast is already wrong. All up, not a bad start to the investing year at all.
* Next Monday (January 20) I will use the key themes outlined in this article to frame my key investment ‘calls’ for the year ahead.
* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.