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Finance - Back from the edge |
If financial markets are to be believed the world economy, with some exceptions, is on track for a strong recovery in the latter part of next year.
The September 11 attacks appear to be a distant memory and the war against terrorism is apparently being won reasonably easily. Confidence is coming back and if it continues to do so the outlook is reasonably bright.
In the immediate wake of the attacks economists cited four main areas of concern that could have led to a prolonged global recession – a big jump in oil prices, a lack of Government response to the fall in confidence, a protracted and unsuccessful war against terrorism with further terrorist attacks, and systemic failure in the economy that would have a domino effect.
So far so good.
Oil prices have actually fallen significantly - to well below $US20 a barrel from levels around $30 a barrel; governments have been slashing interest rates and upped the level of their spending; the war looks likely to be short; there have been no further major terrorist attacks; and so far systemic failure has not occurred.
There were fears that if major parts of the economy such as the airline industry and tourism went into freefall it could lead to a domino effect in terms of bankruptcies and the failure of financial institutions.
But despite the optimism, big risks remain according to such institutions as the OECD. It believes that the US economy will stay in recession until around June next year and then rebound strongly – providing there are no further shocks. Japan will remain a basket case while Europe will initially be sluggish but return to growth later next year. Australia it believes will emerge in relatively good shape.
While the Australian authorities have not matched the US cuts in interest rates our position has been different.
Our economy was stronger, having emerged from a self-induced GST downturn before the attacks took place and government spending has surged.
The Federal Government’s first homeowners’ scheme has boosted economic activity in a wide range of areas and the Federal Government’s pre-election spending spree has seen the biggest increase in Government spending since the Whitlam years. (The economic rationalists who like small government and non-interference in markets must be feeling a little homeless right now.)
Financial markets tend to look six to twelve months ahead and if they are right we seem to be back on track. In the last couple of weeks share markets have rebounded from their post September 11 lows. By the usual rule of thumb a bull market in equities occurs when prices rise more than 20 per cent from their lows. In the US this happened in mid November.
At the same time interest rates, in particular long-term rates, have been rising. This seems to indicate that the market believes that the period of falling interest rates is close to being over. We might reasonably expect at least one more interest rate cut in Australia before Christmas but this will be the last. Interest rates will start rising some time next year.
One black cloud on the horizon will be the real estate market – particularly residential real estate. The market has been booming of late spurred on by low interest rates and the first homeowners’ scheme. With interest rates set to rise and the homeowners’ scheme winding down, there could be a bit of a jolt in store for the industry.
The share market is a tricky one. In Australia the market should benefit from a return of confidence in the US and the end of the election process. One study of the market indicates that a Federal election causes share prices on average to fall by around three per cent in the lead up to the election but recover the lost ground in the following three months. This means share prices could rise until the end of January.
What happens after this is less certain. Normally the expectation of a return to economic growth would spark a rise in share prices. But many analysts still believe that share prices in the US and to lesser extent in Australia are still overvalued despite recent falls. In other words the upside is limited unless we have another speculative bubble.
It does seem that the overall share market returns of the past decade are unlikely to be repeated in the next few years unless there is a big correction down the track.
There are risks to this optimistic scenario however.
The things to watch out for over the next few months that could threaten the revival include: sharply higher oil prices, further terrorists attacks, instability in the Middle East that threatens to topple governments, a failure of business and consumer confidence in the US to pick up, a big fall in the value of the US dollar, and corporate failures, that could lead to a domino effect.
David Tomlinson is a freelance financial journalist.
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