Green shoots - What about the roots?

Posted: September 09, 2009

Share markets world wide have continued their upward trend. Since April the Australian share market has risen over 40%. In many ways, this is what you would expect as a recession comes to an end. Share market investors look to the future for signs of recovery and the positive signs have rebuilt confidence.

What is the good news?

In Australia there is a consensus that the worst is behind us. The Reserve Bank believes this downturn will not be as serious as others in the post war era. Retail sales, exports, house prices and employment figures have all been better than expected. The Westpac Melbourne Institute consumer sentiment index is at its highest since October 2007. Businesses are also more positive with the NAB measure of business confidence at its highest in the last two years and close to its long term average.

In USA economic growth is still falling but at a slower rate causing Barack Obama to declare the beginning of the end of the recession. Many top US companies are still profitable with 75% of the S&P500 businesses declaring better than expected results.

In Asia, growth rates in China improved to 7.9% in the year to June and the overall growth rate of our major trading partners had turned positive. Japan, Taiwan, Korea and Singapore have all surprised economists by showing positive growth.

In Europe, economic growth fell less than expected with France and Germany starting to emerge from recession though Spain and many Eastern bloc countries are still in trouble.

Is the recovery sustainable?

It would be wonderful to imagine the downturn is over and everything is rosy again but there are four key concerns both here and overseas that we should not ignore.

1. Employment - Whilst unemployment has remained encouragingly low at 5.8% in Australia, underemployment - people who cannot get enough work - has been estimated by Morgan Research to be 9%. The problem is more severe in the USA and in Europe. Lack of full employment means lower household incomes, lower consumption, lower tax receipts and higher social security costs.

2. De-leveraging - Many companies in Australia and overseas are reducing debt through capital raisings, internal funding and slashing costs. This means lower levels of business investment and slower growth.

3. Inflation - At some point, central banks will start to raise interest rates again to prevent growth getting out of hand. The Reserve Bank has indicated that it believes a ‘normal' interest rate is well above the current 3% level. Managing the transition from easy to tighter monetary policy will be a delicate challenge over the coming year.

4. Reduced stimulus - Governments will pull back their stimulatory measures. There will be significant pressure to bring their budgets back into balance and start to repay the massive debt incurred in funding the stimulus measures. This means higher taxes, reduced services and/or possible asset sales.

What does this mean for investments going forward?

We expect that all investment markets will continue to be volatile (although not to the same extent as the past year) and interest rates, both short and long term, are expected to rise. Having recovered the "easy yards" share market growth rates should be low to moderate well into 2010. The key focus for investors should be on quality recurring income streams - a theme that we give more attention to inside this newsletter.