The past month has been a wild ride. Global shares were sold off sharply, and high-quality bonds and gold snapped up by investors nervous about slower global growth and Eurozone debt. While volatility may well persist into 2012, at current asset price levels the panic looks to be overdone, with bond yields at unsustainably low levels and share prices discounting a weaker world economy than seems likely considering the strong growth of the emerging economies. The Australian economy remains in good shape by international standards.

Australian Equities – Outlook

The most recent assessment of the state of the Australian economy came from Reserve Bank Deputy Governor Ric Battellino. The gist of his speech on 23 August 2011 was that the two-speed economy is more pronounced than it looked at first. The resources sector has been even stronger than expected, with higher prices and greater investment than predicted, but the rest of the economy has been weaker, due to a combination of household caution on spending and the impact of the exchange rate on domestic producers. The overall effect has been slower growth than earlier thought.

The latest economic indicators have pointed in the same direction. Consumer confidence has weakened a bit further (in the August Westpac/Melbourne Institute survey), and employment growth has dropped away (there was a marginal fall in jobs in July, and a small rise in the unemployment rate). But this slowdown needs to be seen in context. Australia still looks likely to achieve respectable growth by developed economy standards over the next two years: the Bank is picking four percent growth in 2012 and 3.75 percent in 2013, similar to private forecasters’ views.

International Equities – Outlook

Outbreaks of market volatility always looked likely to be a key theme for 2011, but the events of the last month created a coincidence of events that made for an especially turbulent marketplace. At least three strands of concern came together at once.

First was the alarming political brinkmanship in the US over the raising of the Federal government’s debt ceiling: the process itself, the indifference to the collateral damage caused, the loss of the AAA credit rating, the unsatisfactory nature of the eventual ‘resolution’, and the certainty that the whole ramshackle process will need to be revisited at regular intervals.

Second was the re-emergence of the Eurozone debt crisis, which had appeared to have been quarantined to Greece, Ireland, and Portugal, but now had investors looking increasingly askance at Spain, Italy – and even France. Again, the political response by Eurozone governments, while not in the same shambolic league, was widely seen as short of an effective performance. And thirdly, expectations of economic growth, particularly in the US and the Eurozone, were revised down. Various forecasters raised the probability of the dreaded ‘double-dip’ recession in the US, while in the Eurozone the economy that had been touted as the locomotive for the others – Germany – slowed down to almost zero growth in the June quarter. It is still arguable that the reaction to the past month’s events has been overdone. While there is certainly scope for the fiscal problems of both the US and the Eurozone to cause further concerns, the scale of the latest issues is not on a par with the initial onset of the global financial crisis. The Eurozone has a number of potential policy interventions up its sleeve.

Fears about a radical slowdown in growth prospects may also be overdone. It is certainly true that prospects are being revised downwards, and reasonably significantly. In the US, for example, the August Wall Street Journal poll of forecasters showed that the average forecast for US GDP growth in 2011 had been cut to 1.60 percent, from the 2.60 percent forecast in the July poll. This was a substantial revision within the space of a single month. But it may also be an overreaction to the political dramas of the debt ceiling debate and to two particular straws in the wind, the weak Philadelphia Fed survey of manufacturing, and a fall in sales of existing homes. For the most part the ‘hard’ data on actual US economic performance (including retail sales, industrial production, and new jobs) is more positive: the US may well be growing more slowly than expected, but looks to be clear of recession. Even in their current more pessimistic mood, forecasters are picking a gradual pick-up in growth, expecting 2.50 percent in 2012.

It’s also important not to take an overly US-centric or Eurozone-centric view of the world. Outside the US and Europe, where growth prospects are more modest and more questionable, the outlook is markedly brighter. Although the disruption caused by the Japanese earthquake, tsunami, and nuclear disasters has been extensive and prolonged, and has caused supply chain repercussions globally, Japan is moving into reconstruction mode, its economy expected to grow by 2.50 to three percent next year.

And growth is still proceeding apace in the large developing economies. Within the key ‘BRICS’ grouping, both China and India are expected to grow by eight to nine percent next year, while the other three are likely to achieve four to five percent growth.

Volatility, nervousness, and downside risk may well continue to dominate world sharemarkets in coming months, especially as there are no instantaneous silver bullet fixes when it comes to righting governments’ fiscal and debt problems. These require multi-year programs. But there is a better underlying story about ongoing global growth than the current sharemarket pessimism is allowing for.

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This article is reproduced with permission from the Morningstar Economic Update August/September 2011.

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