Economic outlook a bumpy ride
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Economic outlook a bumpy ride
Key Budget initiative flies underneath the radar
By Bevan Graham, Chief Economist AXA Global Investors
The global economic recovery remains on track. This is despite rising concern over sovereign debt levels, particularly in Europe. Deleveraging by households and governments was always going to be a feature of the recovery that would keep economic growth relatively subdued, especially in developed markets.
A front-loading of fiscal austerity measures is expected to constrain near-term growth in some countries. But, as a result, medium-term growth prospects look brighter. While fiscal austerity will have its greatest impact in Europe, the weakness in the Euro will help export growth in the medium-term.
In the meantime, the recovery in the United States is looking increasingly entrenched and the new challenge for emerging markets is to contain economic imbalances in the face of strong economic growth and strong capital inflows. It is this strong growth in emerging markets that is the key contributor to our expectation of global growth of over 4% per annum between 2010 and 2015.
Robust growth and better-than-expected earnings count for nothing when fear is in the ascendancy. We know that fear can be self-fulfilling, if everyone starts thinking a slowdown is around the corner and act accordingly, the slowdown will surely arrive. But an investment strategy based on guessing the expected level of fear (or greed) is a road to ruin.
In times like this it is important to take a dispassionate assessment of the risks and not get lost in the moment. We trust politicians are doing the same, and don’t repeat the fiscal mistakes made during the Great Depression and turn a promising recovery into a double-dip recession. Our assessment of the situation is that European peripheral risk is manageable and markets will eventually move higher on the back of above-trend global growth and a margin-led sustained recovery in profits. Consequently, we remain overweight for growth assets with emerging markets still our preferred asset class.
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Asset class
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Near term view
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Medium-term view
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Current position
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Global equities
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Markets look evenly poised, with fiscal and banking sector worries in a tug-of-war with the ongoing recovery in growth & earnings.
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Positive on current valuations but subdued growth in developed economies points to single digit returns. Emerging markets is our preferred overweight.
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Overweight
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Australasian equities
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Should largely track developed equities. Australia expected to do better than NZ.
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Positive on current valuations. Australia’s higher growth potential translates into higher earnings potential.
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Overweight (over AUS/ under NZ)
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Emerging equities
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Expect emerging markets returns to be an amplification of global equities in the near-term due to their higher beta.
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Should do very well on the back of relatively high GDP and earnings growth, plus lower leverage.
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Overweight
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Property & infrastructure
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Direction of risk appetite is key, but questions are being asked on listed property valuations.
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Listed property looks fully valued. Expect returns to be below other growth assets.
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Underweight
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International bonds
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Government bonds look expensive but the flight-to-safety trade will see bonds do the opposite of equities in the near-term.
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Expect modest returns over the medium-term with credit spreads close to fair-value and low government bond yields. Massive sovereign issuance also means there is upside risk to yields over the medium-term.
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Underweight
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Domestic bonds
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Government bonds offer some equity downside protection but yields will largely take direction from offshore.
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Low long-term government bond and swap yields points to modest returns but NZ deficits and debt ratios look much healthier than most other countries.
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Neutral
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Cash
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Returns from cash will remain below average in the near-term but the asset class is less sensitive to rising interest rates.
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Rates will need to normalise over the medium-term and while cash offers a little lower expected return than other income assets it comes with much less risk.
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Overweight
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Currency
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Expect the NZD to largely track risk appetite over the near-term.
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Despite the recent (MSCI-weighted) decline, the NZD still looks overvalued, particularly against the USD and GBP.
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Below benchmark hedge (MSCI basket)
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By Bevan Graham, Chief Economist AXA Global Investors
In terms of charting out the future path for New Zealand’s economy, Budget 2010 was a tremendously important milestone. However, as we continue to move slowly into a fragile recovery, the budget did not seem to hold the attention of the public or the pundits for very long. After an initial flurry of heated debate, mainly around tax rates, other political, economic and (more recently) sporting issues have dominated.
I would argue that one of the more important budget initiatives flew almost entirely under the radar and did not receive nearly the attention it deserved. There were probably two reasons for this – it was announced before the budget and the truly important part of the policy did not have large dollars attached. That is just the way the media works these days.
It is well understood that innovation is a key driver of economic growth. In the new post-Global Financial Crisis world, it could be said that for the developed or “mature” economies, innovation simply has to be the new comparative advantage.
In fact that comparative advantage is more correctly described as not only an ability to be innovative, but to then successfully commercialise the results of that innovation. It’s a bit like the definition of being an entrepreneur. The true skill of an entrepreneur is not just to come up with a bright idea: it is to also to have the ability to commercialise that bright idea.
Over the last 150 years or so, mature economies such as America, Britain and western continental Europe have reaped the benefits of post-agrarian industrialisation and the pronounced shift to the service economy. Higher productivity has led to higher real wages along the way.
Now however, those same economies are facing a decade or so of paying back the excesses of the last few years. Household and public debt must be repaid and that will necessarily create lower living standards in some countries.
Facing this situation, the question now is where to look to for growth and, in particular, future wealth creation. The answer is innovation.
There are two important considerations when assessing the strength of any innovation system: the strength of the individual parts and, just as importantly, the linkages between those parts. It is the linkages, especially into the business community, that will help determine the commercial relevance of our innovations.
New Zealand has an innovation system which has been shaped by a number of factors: our modest size, our relative isolation and our agricultural economic history. Now is the time to take a broader view of innovation and our collective ability to create wealth from it.
With all this in mind, I read with interest the details of the Government’s pre-Budget Research, Science and Technology package. That package included a mix of new and reprioritised spending. The most pleasing elements of the package, however, were the allocations to encourage linkages and technology transfers between research institutions and businesses.
The intent is that those linkages will lead to a greater focus on business need and the practical ability of our innovations to become commercially successful.
Of course, international linkages are similarly important. We must not waste time reinventing wheels, but equally there is much we can learn from overseas experience.
New Zealand has a low level of expenditure on Research and Development compared to the OECD average. However, it is not the role of government to fix that. After all “government” and “innovation” are essentially contradictions in terms.
The proper role of Government in this sphere is to ensure that when the private sector has a bright idea and is prepared to stump up with some cash, it does so in a collaborative environment which provides the support needed to increase the chances of an innovative wealth-creating outcome.
A real world example of how innovation will play a big role in future success is provided by the struggling automotive industry in the United States. The American car industry has been a major casualty of the recent recession and, to put it bluntly, they will most likely never return to producing cars on the scale they did previously.
Looking past that, I would back America to be at the forefront of the automotive innovations required to develop the next generation of non-fossil fuel-reliant motor vehicles. The wealth creation associated with such a breakthrough will be tremendous.
As a country, our ability to be commercially innovative will be a key determinant of our long-term economic performance. In my view, the government took the right steps to help create the right environment for innovation. The rest is up to the business community.
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Financial Update is a regular publication published by Spicers Portfolio Management. It discusses topical investment and financial planning issues. A free copy of Spicers disclosure statement can be obtained by calling 0800 102 100 or visit www.spicers.co.nz.
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The investment views in this publication do not constitute specific advice (whether of an investment, legal, tax, accounting or any other nature) to any person. The information has been published in good faith and has been obtained from sources believed to be reliable and accurate at the time of preparation. The opinions contained in this document reflect a judgment at the date of publication by Spicers Portfolio Management and are subject to change without notice.