Current events are dominated by fears of a spill over from the Greek Sovereign debt crisis across recently downgraded Government debt raising projects. While it is inevitable that borrowing costs will rise for badly managed heavily indebted countries, the market is likely to calm over time, drawing a distinction between Greece’s long term failure to curb spending and the more recent difficulties of other countries who have begun austerity measures and are beginning to see economic recovery. Nevertheless the Greek blow up is a harsh reminder of the many banana skins that lie ahead. Market nervousness is will remain high leading to extra choppiness in the value of securities.
Double Dip Diminishes
There remains a continued risk of a W shaped recovery in other words a second leg down following the huge global economic contraction of 2008 and 2009, but as each quarter goes by that risk is diminishing as the recovery gains traction. The scale of the recovery can be best measured in a weathervane like the Dow Jones, the US main index of its leading 30 industrials that also reflects global trade. This hit the floor in March 2009 from over 14,000 pre-bust to 6,670 at the lowest point. It is now trading at a little under 11,000 a spurt over 60% in a short 13 months.
Broadly speaking stock markets are 25% shy of their pre-bust peaks and, despite ongoing volatility from nervousness and profit taking, are likely to nudge higher at a far slower pace than the last 13 months of frenetic growth which saw most general equity funds recover two thirds of their losses. That’s because the backdrop is extremely fertile for equities and especially for commodities and energy as red hot demand from fast growing BRIC ( Brazil Russia India and China) economies continues.
Fertilizer for Equities & Commodities
If you want strong grass growth you spread urea fertilizer. If you want businesses and economies to grow you inject stimulus, keep interest rates at historic lows and tempt the Alpine levels of cash estimated at $6 trillion out of banks, money market funds and collective investments funds into real assets. That's happening.
For the moment inflationary pressures remain mute in large tracks of the global economy especially in the US and Europe because of excess inventories and excess labour putting downward pressure on rising prices. So over the short term rates shouldn’t go up by much at all thus threatening growth. That means money remains very cheap for corporations and consumers for the time being. Elsewhere economies ahead of the curve like Australia, Brazil and China, are already moving to cool down overheating economies, by monetary tightening.
The Big Questions
But a big question remains like a trapdoor under this story ; Will sufficient consumers, especially US consumers who account for 20% of the global economy come back out spending again to take up the slack from the fading stimulus packages? The answer is that it is beginning to happen. We tend to forget how skewed US wealth is where the top 10% account for 60% of consumer spending. The biggest spenders, the over 50s carried little or no debt into the crash but suffered a huge blow to their sense of wealth when the stock market upon which they rely, caved in. The significant bounce in the value of US corporations is helping to raise consumer confidence far faster than many had thought and is confounding sceptics who’d prematurely written the US economy’s graveside oration.
The second big question is yet to be decided. National Governments have socialised much of the toxic debt hoping to raise taxes and cut spending in faster growing economies over the next few years to scale back ballooning debt/ GDP levels that threaten their credit ratings and future borrowing ability. Just how these programmes can be politically delivered remains up in the air as the UK general election campaign showed as each political party fudged post-election cuts and taxes policy. In that regard Ireland is, at least for the moment, enjoying first starter advantage over many countries including fellow PIGS, those Euro countries with bloated deficits.
While there remains a risk a contagion spreading for the moment from the near default of Greek Government debt following 11th hour intervention by the EU and the IMF, the Euro will remain damaged until such time as the Maastricht Treaty is renegotiated putting some type of architecture in place to prevent repeats. So expect further Euro softening against the Dollar and Sterling but for that to reverse as attention refocuses on the scale of US and British debt over the times ahead.
If Banana Skins Can Be Avoided
Provided the global economy can avoid other banana skins like the $1 trillion resetting of deeply discounted US residential mortgage debt known as ARMs, a string of Sovereign debt defaults or becoming choked by unaffordable oil and commodity price, the outlook for the next few years should be;
- Global economic growth of 4% to 5% per year
- Low interest rates remain well into 2011 in Europe and the US
- The ECB base rate currently at 1% unlikely to break out above 2.5% before 2012
- Asia excluding Japan to perform best followed by Europe and the US
- Commodity returns likely to outperform especially oil and precious metals silver and platinum
- Equity markets likely to pause in 2011 before moving strongly forward with the risk of some pull back this year remaining
- The Euro to fall further before rallying on the strength of higher European saving rates, lower overall debt and more competitive exports
- Conventional Government Debt at risk of falls in value as rates rise and inflation tip toes back. Index Linked Government Bonds to fare far better.
- Cash returns to remain very poor and at risk to inflation.
- China which is quickly becoming a voracious importer to reset its currency up against the Dollar.
- Property in Europe and the UK while regaining some ground will repair slowly as the banking sector recovers and grapples with tighter regulation and less lending.
What happens when the Mayan Calendar Ends?
In my assessment, after 2012 I can’t see how a prolonged period of high inflation can be avoided as two forces converge. The first is the huge increase in money supply generated by extra Government debt over the past few years as it begins to increase in velocity in a normalised banking environment and the second is a return to high oil prices as strong Non-OECD demand growth outstrips supply hindered by underinvestment in infrastructure and larger than expected decline rates in jumbo oil fields.
That's why for private investment I continue to favour switching from conventional Eurobonds to Index Linked bonds and allocating up to 10% to precious metals on the one hand while spreading much of the remainder across European High Yield stocks, the Pacific region and especially energy, natural resources, green energy, water and energy efficiency.
For monies held within pension wrappers like personal and company pension schemes, long term investors should remain concentrated on an uncorrelated mix of diverse “risky”assets. Managed funds should be examined for their allocation to the above themes and investors should carefully consider moving to themed funds if their managed funds are not moving with the times.
Those close to retirement ready to draw cash down by buying a pension annuity or phased encashment from a post-retirement fund (ARF) should very carefully consider reallocating to funds less exposed to high inflation and volatility now. This needsconsidered advice with an emphasis on indexed Eurobonds in particular.
The above is my best assessment of data at the moment but I'd caution readers that, in this climate everyone's crystal ball s is pretty foggy, unreliable and likely to be blown off course by overwhelming short term events ie, other risks that materialise which have escaped general attention. Forecasts, especially short term forecast, are invariably wrong it's just a question by how much- nevertheless, the above are the assumptions I’m applying over these challenging times and I hope you find them useful.