Boom Or Bust: Will We See Balance In 2012?

Zurich’s Matt Drennan bemoans the lopsidedness of the local economy but believes there is reason for optimism in 2012.Having read a lot of commentary on the current Australian Government’s problems and key drivers, I have come to the conclusion that the fundamental issue is relatively simple. They are more interested in the problem of how the economic pie is distributed rather than balancing this with a focus on how to grow the pie. This is reflected in a rising crescendo of criticism from prominent business leaders and lobby groups, and plummeting productivity.

Despite this lack of focus on economic growth, Australia did stunningly well in the September quarter posting an expansion of one per cent. This surprised everyone, including the Treasurer. After recovering from the shock, he went on to pronounce that the Government had got the balance right between consumption and investment. Tell that to people working in tourism, university education or manufacturing. The lopsidedness in the economy is stark. In Cairns, tourism operators are boarding up their shops due to the lack of business, while up the road Gladstone is a boomtown out of control. In short there is no balance, only massive winners and massive losers.
Despite this, the key problem faced by the Government in the current environment is not the high dollar, nor the carbon and mining taxes, nor even the knock-on effects from the European debt crisis. It is industrial relations.

While industry leaders are quoted daily bemoaning the inflexibility of the Fair Work Act and the need for substantial revisions, unions are pushing for even more say in how businesses are run. The result? A 50 per cent spike in industrial disputes in the last quarter.
At present the mining boom is papering over many of the cracks in the industrial landscape, but there is a real risk that Australia will emerge from this boom with a hopelessly outmoded industrial relations system in a world that demands ever-increasing flexibility. Unwinding this system even back to what we enjoyed three years ago will take decades.

22 cents. That is the amount out of every dollar our banks need to fund in the offshore bond market to meet the shortfall in domestic savings, which funds their loan books. Since much of this is financed in Europe, it is becoming increasingly difficult and expensive to manage. Witness the recent covered bond issue from CBA, which was pulled. Trying to belt the banks over the head for their reluctance to pass on the latest interest rate cut is short-sighted and ultimately unproductive. It displays gross naivety about how banking works. Even if banks could finance new lending from the surge in domestic savings, they still need to roll over the vast amounts of existing bonds at higher rates as they mature.
Ultimately passing on rate cuts in full will result in skinnier margins; less of a buffer from adverse global events; a combination of shrinking loan books, redundancies in the banking sector; and, I suspect, another round of political whingeing about these outcomes.
A brighter outlook for investors

As Santa’s reindeer begin their intensive training program to limber up for the coming Christmas marathon, investors’ minds are turning to the New Year and what lies ahead. But before we know where we are heading we must reflect for a minute on where we have been.
Good riddance to 2011! Happy to see the back of you! Hasta la vista baby! Well, I think that’s enough reflecting. Unsurprisingly, most assessments for the 2012 outlook appear akin to the re-run of a bad movie. At the time of writing, Europe is mired in yet another talkfest, equity market volatility is as high as ever and China’s economic growth has slowed markedly. True, things don’t look brilliant, but there are some signs of improvement, particularly from an investor’s perspective, as opposed to that of an economist.

Back in the saddle again. All this leads back to the old hobby horse: there is a growing wall of liquidity building in the global financial system and, based on past experience, at some point this will find its way into equity markets. Australia has become the latest country to reinforce this trend with our recent rate cuts. How long will investors be happy to reinvest in cash and term deposits as yields decline? The average annualised yield on a six-month term deposit has now dropped to a modest 5.3 per cent. Low rates could be the catalyst to see a return to equities, but ironically so could Europe. Things don’t have to get better there; they just have to stop deteriorating so the world can focus on something else.

But surely equity markets need a strong economic backdrop to perform? No, not in the short term, anyway.
A falling Australian dollar would provide a strong kicker to returns from global equities and, as I have noted previously, many US companies are performing extremely well. With “risk off” now firmly the consensus, and our relative interest rate differential narrowing, the Australian dollar has more downside than upside, in my view. Ultimately, though, any catalyst will rely heavily on FOMO (fear of missing out, not FoFA!). The fear of missing out is a powerful incentive quickly turning bears onto bulls and brushing aside any memory of the bad times. When will this occur? I haven’t the faintest idea. But the fact that there is almost unanimous opinion that 2012 will be a bad year for financial markets is an encouraging sign!

By | 13.12.2011