PORTFOLIO POINT: Here are 12 bold calls about what might happen in 2012 '¦ which might turn out to be a very interesting year.
"It's tough to make predictions," baseball player and Zen philosopher Yogi Berra once said, "especially about the future." This is no more so when that future is constrained by a time frame. And as readers will be aware from previous attempts here and elsewhere, a year – too long to be short-term, too short to be long-term – is an especially difficult time frame to get right.
I'm going to toss the rune stones and give it shot anyway because 2012 is shaping up to be a most interesting 12 months and, as Berra also said: “The future ain’t what it used to be.”
1. Brent Crude will stay above $US110 a barrel, possibly reaching $US150
Of all the pivotal events of 2011, for me the biggest was the Arab Spring. The fall of dictatorships in Tunisia, Egypt and Libya not only changed the dynamics of the Middle East, but gave a new impetus to “people power”, strengthening the resolve of other movements in the US and Europe, not to mention now Russia and India (click here). For investors the biggest impact, however, was on the price of oil, although there’s an argument that televised images of the revolution added to the skittishness in the markets in general. And with the Arab Spring not over – regimes in Syria, Yemen and Iraq are teetering – elevated oil prices can be expected to continue. Tighter oil supply on such geopolitical dynamics will drive up energy prices from other sources, including green energy and renewables.
2. The euro will remain, but fall to parity with the US dollar. Britain will edge closer to leaving the Union (though not the common market)
In contrast to the swiftness of regime change in much of the Middle East, political progress in Europe seemed glacial in 2011, creating a self-fulfilling cycle of doubt and uncertainty exacerbating concerns over Greece’s solvency and the economic health of other southern European countries, plus Ireland, hit by the GFC several years earlier. I’ve always been sceptical about the fear and panic surrounding the future of the eurozone, seeing its geopolitical importance as of far greater value than any level of debt accumulated by its more profligate members. And with bloodless regime change in fact being achieved in both Greece and Italy (see New Euro Order), the commitment to the European project seems to have borne out.
In 2012 I see the eurozone not breaking up, but consolidating, with greater fiscal integration between its members. As German politicians dither about austerity and retribution, Nicolas Sarkozy’s France will continue to quietly lead policy developments (aided and abetted by the IMF, led by former Sarkozy minister Christine Lagarde) with a focus on the eurozone-17, not the EU-27. Britain, Sweden and Denmark will happily stay on the sidelines as an E-17 fiscal union takes shape. Meanwhile, Britain, in particular, will move back to a more Atlantic orbit with PM David Cameron attempting to appease his Tory backbenchers by winding back the clock on some of arrangements made by his predecessors.
A Europe led by a stronger voice from France will also more likely see sovereign debt purchases from the European Central Bank, a move that will inevitably be likened to the quantitative easing policies of the US Federal Reserve and central banks in Britain and Japan (and opposed by Germany but few others). This will aid Europe’s economic recovery, but drive down the value of the euro and raise, somewhat, northern European inflation, albeit unlikely to a point where it will have any real negative impact. Moves in 2011 under newish ECB president Mario Draghi to drop interest rates twice and flood European banks with cheap money are just a taste of dovish monetary policy to come.
3. The US dollar will advance against the Euro and other currencies, though not at the expense of a mild recovery or Obama’s re-election
The US economy will continue its mild recovery in 2012, but the emphasis should be on the word mild. Job numbers, housing starts and business investment indicate a growing optimism notwithstanding a high amount of debt deleverage that’s still yet to work its way through the economy and an appalling spectacle of political ineptitude in Congress. This mediocre mix of affairs, however, might ironically serve to get Barack Obama re-elected later in the year with the Republican Party painting themselves into a far-right corner of increasingly hysterical and counter-productive policies.
4. A hard landing in China will lead to a more repressive government and lower bulk commodity and base metal prices (except maybe gold)
Chinese economic growth will fall to sub-inflation levels (ie, recessionary levels) of 5% or below in 2012, though this will cause more damage to the commodity-oriented economies of Australia, South Africa, Brazil and Canada than the world at large, or indeed China itself.
As for the commodities that have risen on the back of China’s construction binge, iron ore, copper and coking coal will be obvious victims, but thermal coal and other energy commodities (oil, natural gas, uranium) will enjoy continued demand, though negative sentiment around resources as a thematic may temporarily dampen prices. Gold prices will also fall on a similar dynamic (and on the view that the US dollar is not cactus after all!), but ironically it may find support on Chinese demand should the country’s otherwise highly restricted investors take money out of property and shares and put it into gold jewellery, inevitably bought at mega-chains like Chow Tai Fook (for more analysis on this retail phenomenon, click here and here.
China’s government will otherwise have limited recourse in terms of preventing a house price crash or a fall in infrastructure investment. Increasing money and credit supply to prop-up the fixed-asset bubble will be impossible without causing further political unrest (in the Arab Spring, inflation – especially food price inflation – ignited the first protests) and, as such, any cash reserves left over from the epic fiscal stimulus packages of 2008-9 will be used to bail-out local government investment vehicles and state-owned banks that bet hard, as Australia did, on China’s “build-it-and-they-will-come” economic model. If a credit crunch were to break out in China this would not only endanger the Communist Party’s rule but the entire world economy (meaning a far gloomier outlook for Europe and America than the one I’ve described above).
With stability and the maintenance of power firmly in mind, we can assume that Beijing won’t let a credit crisis happen. Profligate and corrupt local and provincial governments will, however, be stripped of power and expenditure will be more centralised. Political repression will also be stepped up a notch, coinciding with an increased role for the military and leftist hardliners from the so-called “fifth generation of leadership”, who come to power in the next (18th) Politburo of the Communist Party of China, which happens in October/November.
5. A terms-of-trade shock in Australia will lead to: 6. Mild recession; 7 Falling interest rates, 8. A rise in unemployment; 9. A house price crash, 10. A domestic equities bear market; and 11. A change of government
Just as Australia stood alone among the rich world when the GFC happened, Australia will stand alone when the GFR (global financial recovery) happens. Due to our unique reliance on resource exports to China – thanks to an equally unique over-exposure in banking to foreign debt markets and a sharemarket dominated by the mining and banking sectors – when China sneezes on an over-enthusiastic property and infrastructure bubble, Australia will catch a cold, to say the least.
Should GDP growth enter negative territory on such a development, a fall in RBA interest rates won’t be enough to prevent the likely collapse in credit supply for Australia’s domestic banks, which have to date been far too reliant on offshore enthusiasm for our debt and dollars. This in turn will mean many businesses, equally reliant on the banking credit cycle, will have to reduce staff even if their supply-chains and customer base have nothing to do with the resources sector. As businesses and consumers alike deleverage and reduce outgoings, housing and equities prices will too invariably fall, creating a self-fulfilling cycle until a floor is reached and value-seekers (hopefully all of them Eureka Report subscribers) come back into the market.
As with the US, price-to-rent and price-to-earnings multiples will stabilise at some point after what we’ve been through but the recovery will be slow as all housing and credit-led slumps are, meaning that investors will have to exercise discipline, patience and discernment if wanting to feed at the bottom of the cycle. The good news is that a China-led recession will lower the Australian dollar, giving a boost to our tourism and export sectors, which are already suffering a virtual recession. Hopefully it will also cause our economy to rebalance on a more sustainable and diversified footing, but this will depend on how forward-looking the policies of the next Coalition government are, should it come to power on the back of a Labor or independent backbench revolt prompted by an economic slump.
12. Technology will continue to lead the way
One bubble that’s unlikely to burst in 2012 is the new tech bubble of mainly American social media, internet and consumer electronics stocks. Companies like Google, Apple and Facebook will continue to be seen as bright lights in a gloomy world (and there is also hope for Australian operations, demonstrated by the successful private equity raising for social media start-up Kaggle) and as ICT infrastructures such as the national broadband network in Australia continue to roll-out across the world, more and more companies and innovations will come to the fore.
In the long-term this will jeopardise many jobs, businesses and industries, with technology invariably creating redundancy elsewhere (see Made redundant), but overall consumers and businesses will benefit from the productivity and efficiency gains of the world’s continued digitisation. Green technology and healthcare companies will likewise stand out in 2012, though individual corporate failures – such as Solyndra – can be expected anytime in any frontier industry,
Separately, if a major environmental or biotechnology investor such as China hits economic turbulence, those industries will invariably face headwinds.
Geopolitical concerns arising out of North Korea will also distract policy-makers in South Korea, Taiwan and Japan – three centres of high-tech industry – but just as necessity is the mother of invention, difficult geopolitics can sometimes be a boon to the development of technology: witness the example of Israel.
Just as with 2011, 2012 will be a challenging year for most investors, especially in Australia if the above is remotely accurate. Let’s hope it’s not.