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A global economic recovery does not mean business as usual.

August 24th, 2009 · Greg Atkinson · 16 Comments

After the strong stock market rally today I think we can safely say the bear market of 2008-2009 is now well and truly over. The ASX All Ordinaries & ASX 200 are still clearly trending upwards and commentators who were predicting a Global Depression just a few months ago have started adjusting their forecasts.

But although there are plenty of economic indicators around that suggest the Australian economy is holding up well and that a global economic recovery is taking hold, I believe it is important for investors not to blindly leap back into stocks. Money can be also lost in bull markets!

As I have mentioned a few times I feel pretty confident that the Australian stock market will continue to rise but it will probably struggle to break through the 4800-5000 level on the All Ords & ASX 200. I hold this view simply because I believe the Australian economic outlook according to the RBA (and Treasury) is overly optimistic and that over the next few months company earnings will show that economy is still struggling.

The major problem with the RBA’s economic outlook in my opinion is that they assume that China’s demand for Australian resources will remain strong. Maybe they are right, but I have my doubts.

Just because the global economy is slowly crawling out of a hole does not mean it will be back to business as usual any time soon. Many developed nations have gone heavily into debt in order to spend their way out of trouble and this means in the years ahead governments across the globe are going to be looking at ways to pay off this debt. This means over the next decade we are going to see governments cut back on spending, raise taxes and this will put a drag on consumer spending.

So it is unlikely that we will see the global economy surge back to the level reached in 2007/2008 no matter how much money the Chinese Central Government pumps into building projects etc. Therefore it is unlikely that the demand for resources from China (and other nations) will ramp up again and in fact it may even weaken somewhat when the Chinese Government eases back on spending at some point.

What is more likely to happen over the next few years is that there will be a gradual recovery across developed nations, perhaps higher growth in some emerging economies and dare I suggest it, a slowing down in the Chinese economy. If something like this was to unfold over the next few years then prices for commodities such as iron ore and coal will remain well below their 2008 highs.

The Baltic Dry Index has been trending down since June and this may suggest that a weakening in demand for commodities is already starting to be felt. If you then factor in that both RIO Tinto and BHP Billiton are somewhat cautious about the outlook for commodities in the short term then it is hard to see how any iron ore or coal miner would be able to rise prices.

In addition oil prices are struggling to hold above $70 USD a barrel even with OPEC cutting production, gold demand for industrial use is down and major airlines are reporting that passengers numbers are still way below normal. This suggests that there is still some economic pain to trickle through the system and that some companies will still struggle well into 2010 at least.

We also need to factor in the impact of the measures aimed at reducing C02 emissions and in many developed nations this is likely to mean higher costs for consumers and businesses. This will put a further drag on economic growth in the developed world, but on the other hand probably help growth in many developing nations where they will most likely end up merrily pumping as much C02 into the atmosphere as they like.

This current global economic recovery will have it’s own unique character. Some sectors in the economy that were strong over the last few years may fare poorly in the future, whereas other sectors overlooked for years may surge ahead. Maybe commodities exports from Australia to China and Japan will surge once more but then again, perhaps heady days of 2007/08 may never return?

At this stage all that anyone can do is to try and guess what form the global economy will take. There is also a very real danger that many countries will slip back into recession once government economic stimulus measures are scaled back, and so it is possible that the global economy will face another period of decline if that happened.

It is important therefore not to be carried away by the excitement stirred by stock market rallies and talk about economic recoveries. It is still very early days and although stocks are out of bear market territory, this does not means they will get anywhere near the highs of 2007 within a few months.

Yes we seem to be seeing an economic recovery, but the question that still needs to be answered is: a recovery to what?


16 responses so far ↓

  • 1 Gary // Aug 31, 2009 at 7:52 am

    What impact do you think higher interest rates will have on the economy?

  • 2 Ned S // Aug 31, 2009 at 11:22 am

    Stumbled on this – No idea if he knows his stuff but thought it was interesting anyway. (Including the comment “… if a strong dollar is likely to pop a Chinese stock bubble, the Chinese have the motive and means to prevent a strong dollar. …”)

    http://www.ritholtz.com/blog/2009/08/andy-xie-china-has-become-a-giant-ponzi-scheme/

  • 3 Greg Atkinson // Sep 1, 2009 at 8:18 am

    Hard to know about China isn’t it? Some people are bullish on China (Jim Rogers for example) but there are plenty of others who are bearish. I personally get the feeling that China will come back to earth and need to deal with reduced growth and even have their own recession at some point. Fantastic economic growth stories don’t last forever.

    I agree with what you say about China having the means to prevent a strong dollar..or even weaken it if they want. Interesting to see how the US – China relationship is changing as a result of the GFC, money really does talk!

  • 4 Ned S // Sep 1, 2009 at 9:33 am

    Seems that Andy Xie bloke might know his stuff. He gets top billing here and Kitco’s Nadler is actually quite conservative from what I’ve seen:

    http://www.kitco.com/ind/nadler/aug312009.html

  • 5 Greg Atkinson // Sep 3, 2009 at 1:17 pm

    Ned S – thanks, this was an interesting article. I am pretty cautious about China as well. I note they are also bearish about gold and I am in that camp also.

  • 6 Pete // Sep 3, 2009 at 3:16 pm

    Andy Xie is predicting a correction soon, for a variety of reasons.

    Here

    But if you don’t like him anymore, I understand.

  • 7 Ned S // Sep 3, 2009 at 4:26 pm

    Thanks Pete – Andy Xie even puts time frames on it there – Qtr 4 2009 for China and Qtr 1 2010 for the US. Hope he’s wrong though – It’s selfish I know but I’d actually started looking forward to interest rates going up a bit.

  • 8 Greg Atkinson // Sep 3, 2009 at 4:42 pm

    Pete – Ned S sent me a link to a article by Andy Xie recently, it was interesting reading. He has given a time-frame and is not selling a newsletter, so I have no problem with what he is saying. It would have been nice if he had said how big the correction would be but he is an economist, so I can forgive him 🙂

  • 9 Pete // Sep 3, 2009 at 7:17 pm

    Greg:

    How can you possibly guess how big a correction will be?

    I mean, you can probably discern between a very small blip and a significant correction, but to say “the ASX will drop to 1000 by January 2010” is far too hard to predict.

    Although, if they use technical analysis I am sure they could give you some kind of figure…but I personally think technical analysis is almost useless in these volatile times.

  • 10 Ned S // Sep 3, 2009 at 8:03 pm

    No specific figures except to say “When the Fed’s policy rate reaches 5 per cent, probably in 2011, Hong Kong’s property prices will be 50 per cent lower.” But he sure doesn’t seem to be talking about a 10% to 20% correction to me. Some quotes:

    “By the middle of the second quarter next year, most of the world will have entered the second dip. But, by then, financial markets will have collapsed.”

    “By next spring, another stimulus story, involving even bigger sums, will surface. “Experts” will offer opinions again on its potency. After a month or two, people will be at it again. Such market movements are bear-market bounces. Every bounce will peak lower than the previous one. The reason that such bear-market bounces repeat is the US Federal Reserve’s low interest rate.”

    “The final crash will come when the Fed raises the interest rate to 5 per cent or more.”

    And the “good” news:

    “We are not in the midst of a new boom. We are at the last stage of the Greenspan bubble. It ends with stagflation.”

    Doubt he’s going to get to be guest speaker at Benny B’s reinstatement ceremony!

  • 11 Greg Atkinson // Sep 3, 2009 at 9:39 pm

    Pete by range I mean is the correction 5%, 10% or 50%? A least a ballpark figure means the person making the call has to quantify how severe the correction will be. I have read a lot of correction calls where the person takes credit for even a blip of less than a few percentage!

    I am no great fan of technical analysis apart from using the charts to more easily see trends. There is no system in the world that can accurately predict the future, but candlestick charts etc. can help you get a feel for what the markets has been doing.

  • 12 Ned S // Sep 4, 2009 at 9:30 am

    One can always find a way to explain anything – A recent article I read reckons that stocks are doing really well specifically because the expectation is that the global recovery will be slow and weak and sentiment is so lousy. With the logic being that this will keep interest rates and inflation low and stimulus will remain high. And it trots out a bunch of historical examples to prove that is how it works with the strongest stock price recoveries coming at times when the recoveries are weakest. So much for “fundamentals” hey?

    With another writeup that still seems to think boring things like P/E ratios are important saying:

    “In March, stocks traded as low as 11.7 times their average earnings over the previous 10 years, adjusted for inflation, according to finance professor Robert Shiller of Yale University. That put the market at its lowest valuation since January 1986.

    Today, however, stocks are selling at 18.4 times Shiller’s measure of earnings. That isn’t only up hugely from March but is above the long-term average of 16.3 times earnings.”

  • 13 Greg Atkinson // Sep 4, 2009 at 11:13 am

    Ned S – I am generally wary of P/E ration simply because they can change so quickly. One minute analysts are saying they at low levels, then they rework their models and suddenly they are above the long term average. Having said that you need to keep an eye on such things because they often get taken into account by trading programs and fund managers etc.

  • 14 Pete // Sep 4, 2009 at 11:29 am

    Good points Ned/Greg.

    P/E ratios are a problem, because they rely on data for:
    – Price
    – Earnings

    I know that is obvious, but it is a two factor variable, meaning that changes will also be two factor.

    For instance, lets pretend a companies share price is $1.00 and the earnings is 10c.

    P/E = 10

    Price increases to $1.50 on speculation, but actual earnings drop to 6c.

    Those changes seem fairly minor right?

    Well now:
    P/E = 25

    I know that is elementary mathematics, but my point is that if there are changes on both variables then the overall change will likely be quite large.

    The fact that companies can use some creative accounting to adjust these values is also a worry.

    Let’s say the example company above uses creative accounting to increase earnings to 8c instead of 6c, and throws some ambiguous bad news into the mix (get the CEO to sell some shares) to drop the share price briefly to around $1.30.

    P/E = 16

    I am not sure how often those kind of things happen, but it would certainly make companies look more desirable for large investors…maybe super funds? That is my speculation anyway.

    Personally I do not trust the accounting of most companies, although the miners have far less room to move in that respect. Financial companies are the ones that I think are particularly dodgy here.

  • 15 Ralph // Sep 7, 2009 at 2:53 pm

    I wouldn’t call it completely over just yet. It seems that confidence is brimming over, doesn’t it? But I reckon there’s plenty of uncertainty not far beneath the surface. To my mind, the whole show is basically running on stimulus cash, in practically every economy. I’m still nervous about that and reckon there’s a few bumps in the road yet. I’d like to see how things go once the funny money starts to get wound back before I get too excited. Interest rates look like they are on the way up. There’s just too much debt in the system. Then there’s oil. I personally reckon that peak oil is a real sleeper once demand picks up again, but who really knows on that one.

  • 16 Greg Atkinson // Sep 24, 2009 at 7:12 pm

    Ralph we have avoided a global economic meltdown but at what cost? For sure many western nations are going to struggle with massive debt and already tax increases are slowly (and as quitely as possible) being introduced.

    I agree with your comment about oil. Once we forget we all love solar power our demand for oil will pick up again.

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