How will the Australian economy perform in 2009?
 
“The lesson…is that no one’s any good at forecasting anything……”
Quote from Rory Robertson, interest rate strategist, Macquarie Group. Printed in BRW, December 4 – January 7 2009

Many of the world’s largest economies are in recession or look to headed that way in the near future. The US appears to be a basket case, its Government has relatively few options for stimulating its economy as there is virtually no room to move on interest rates, it has no surplus funds and a ballooning budget deficit. Its financial institutions are a mess and continued declining asset prices make them look worse by the day. The UK is not much better and Germany, the largest economy in the EU, looks set for negative growth during 09. Many smaller EU economies are much worse off.

The sky is falling in! When will it stop and will Australia be pulled down the plughole with the US and Europe?

The good news is that Australia’s major trading partners are in Asia and are looking to be in significantly better shape than those in Europe and America. Japan has had a stagnant economy for years and is expecting modest growth. South Korea is expected to experience modest economic growth. China’s growth is expected to slow, from 12% to as low as 7%. However, 7% is still very strong growth by world standards and this is at the bottom end of most expectations.
Residential Housing Prices

There has been a lot of speculation in the media about property prices. There is no doubt that prices have fallen in some segments of the market, most notably the upper end and many regional areas. However the overall residential market has held up relatively well. The real price of housing is directly related to interest rates, which have fallen significantly during recent months and further interest rate cuts seem inevitable. Housing has become a lot more affordable, even without a slump in prices.

Falls in housing prices have been a major contributing factor to the current global turmoil, as they have destroyed the capital position of lenders. It is unlikely the RBA will allow this to happen in Australia. Unlike the US, it has plenty of scope for further interest rate cuts.
How will this effect investment markets?

The Australian share market is currently experiencing its worst slump since the mid 1970’s. With the value of many shares having fallen by 50% or more from their highpoints it would seem, on the surface, to be a great time to buy. This may turn out to be the case, however, it has to be recognised that there is still a great level of uncertainty with regard to the likely performance of the world economy, and its effect on the profits of Australian companies moving forward. There is no doubt the current price to earnings ratios and historical dividend yields are attractive, but are current profits and dividends sustainable?

It seems likely that company profits will, on average, fall during 2009. Lower demand from consumers both domestically and overseas will ensure this. Similarly, the difficulty of accessing either debt or equity funding will curb the growth of many businesses. However, there will be long and short term beneficiaries of this situation. Who these will be is up to you and/or you chosen fund managers to work out.

The share market usually responds in advance of actual profits, so if company profits look to be stabilising or rising, there is likely to be an increase in price to earnings ratios immediately. It is widely thought that there will be some improvement in the second half of 2009 or early 2010, if this view firms, there could be a recovery in the share market as soon as the first half of 2009. However, this is speculation, and the fact is that no one knows when a recovery will take place.
Out of crisis comes opportunity?

Economies have always been cyclical, more so prior to the Great Depression than since, as Governments worldwide have, mostly, acted to curb sharp movements in economic growth, both positive and negative. Nevertheless, cycles remain a factor of the world economy. It is simplistic to look at this and consider positive moves to be good and negative to be bad. Hard times cull weaker players and poor business practices and allow strong, well-managed businesses to gain market share. Similarly, they allow disciplined investors to outperform speculators and those who follow fads.

General consensus is that, in the longer term, the Australian economy will continue to grow, and the value of Australian property and businesses will appreciate. It is also fact that share prices are currently selling at price to earnings ratios that are below their historical averages, while dividend yields are above average.

One certainty is that there will be both businesses and investors who will make remarkable profits out of the current business environment. A large proportion of these successes are likely to come from people who remain focused on long-term opportunities.

The challenge for investors in the first part of 2009 will be how to take advantage of opportunities, while protecting themselves from likely short-term volatility.
Some Food for Thought

There is a report produced annually by a company in the US called Dalbar. The report tracks the success rate of the average managed fund investor. Its findings indicate that between 1985 and 2006 the average managed fund investor underperformed the average market return, by 6% per annum. The primary reason for the underperformance of individual investors was shown to be because of the timing of their entry and exit from their investments.

Investors have a tendency to try and time the market, buying when things are going well and selling when performance turns. Unfortunately those that follow this strategy often miss a large proportion of the growth cycle on the way in but realise a large proportion of any declines.

Legendary investor Warren Buffet is often quoted as having said “be fearful when others are greedy and be greedy when others are fearful”. Fear is definitely the most prevalent emotion in investment markets at the moment, if you agree with Mr Buffet now is a time of extraordinary opportunity.