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Economic and market prospects
Brian Parker CFA
Investment Strategist
MLC Investment Management
July 2008
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Global economy
•
•
•
•
Sub-prime crisis has morphed into global financial crisis
US is in recession
No economy is immune
The downturn is likely to be shallow, but drawn out, and recovery
is not going to be spectacular
• China is well placed
The US economy is probably in
recession already
Consumer confidence is already
at recession levels
135
125
US Univ. of Michigan consumer sentiment indices
GDP growth is OK, but the leading
indicators look lousy
10
Expected conditions
Current conditions
8
Annual change %
Conference Board leading index
Real GDP
115
105
95
6
4
85
75
65
55
45
35
Jan-81 Jan-86 Jan-91 Jan-96 Jan-01 Jan-06
Source: Thomson Financial Datastream
2
0
-2
-4
Q1 1988 Q1 1992 Q1 1996 Q1 2000 Q1 2004 Q1 2008
US housing: the state of play
..helping to create a huge overhang of
unsold homes
Home sales have plummeted..
8500
'000 annualised
12
7500
Unsold single-family homes to total sales ratio
10
6500
8
5500
6
4500
Total home sales (new + existing)
3500
2500
Jan-93
4
2
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06
Housing starts have fallen in response
to sharply weaker demand..
..but more forced sales are likely as
delinquency rates have soared.
2500
4.0
Delinquency rate % of loans outstanding
3.5
2000
3.0
1500
2.5
2.0
1000
1.5
Housing starts (lhs)
1.0
500
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Source: Thomson Financial Datastream
Jan-08
Q2 1990
Q2 1993
Q2 1996
Q2 1999
Q2 2002
Q2 2005
Housing affordability has improved…
150
US Housing Affordability Index
140
130
120
110
100
90
Jan-88
Jan-91
Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
..which is a fat lot of good because the
banks aren’t lending!
US Consumer lending standards are
tightening..
Net % of lenders tightening standards
Credit cards
80
Other consumer lending
Prime mortgages
70
Sub-prime mortgages
90
..as are standards for both large and
small businesses..
70
60
Net % of lenders tightening standards
Large & medium firms
Small firms
50
60
40
50
30
40
20
30
10
20
0
10
0
-10
-10
-20
-20
-30
Q3 1998
Q3 2000
Q3 2002
Q3 2004
Sources: US Federal Reserve, Datastream
Q3 2006
Q3 2008
Q3 1998 Q3 2000 Q3 2002 Q3 2004 Q3 2006 Q3 2008
It’s not just a US problem...UK, European
banks are also tightening standards
..as are those of their British
counterparts
..while European bank lending
standards are tighter..
50
Net % of lenders tightening standards next qtr
40
Net % of lenders tightening standards next qtr
20
Business lending
Corporate
credit
Household
credit
10
Consumer lending
30
30
0
20
-10
10
-20
-30
0
-40
-10
-50
-20
Q2 2003
-60
Q4 2004
Q2 2006
Q4 2007
Q2 2007
Q4 2007
Sources: European Central Bank, Bank of England, Thompson Financial Datastream
Q2 2008
How much more debt can be rammed down the throats
of consumers in the English speaking world?..
Australian household debt
%
180
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
UK household debt
%
180
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
Source: Thomson Financial Datastream
US household debt
180 %
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
Inflation: getting to the core of the matter
US
Annual inflation rate (%)
5.0
4.5
Headline
4.0
3.5
3.0
2.5
2.0
1.5
1.0
Core
0.5
0.0
Jan-97 Jan-99 Jan-01 Jan-03 Jan-05
Eurozone
4.0
Annual inflation rate (%)
3.5
Headline
3.0
2.5
2.0
1.5
1.0
Core
0.5
Jan-07
Japan
Annual inflation rate (%)
3.0
2.5
2.0
1.5
Headline
1.0
0.5
0.0
-0.5
-1.0
Core
-1.5
-2.0
Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07
0.0
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
• Apart from food and energy, inflation is
reasonably subdued
• ECB/Fed worried about headline rates
causing higher wage/labour costs but…
• ..slower growth should ease these
concerns (not soon enough for the ECB)
China is not immune, but is well placed to
weather the storm
Export growth has slowed only slightly,
while imports have accelerated
China's growth eases back somewhat
Annual change (%)
20
18
16
14
12
10
8
6
Industrial output
4
Real GDP
2
0
Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008
China's non-food CPI has picked up, but
from a very low base.
Annual change (%)
10
9
8
Headline CPI
7
Non-food CPI
6
5
4
3
2
1
0
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
60
50
40
Annual change (%)
Exports
Imports
30
20
10
0
-10
-20
Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008
• Chinese exports have slowed a little, and
are likely to slow further, but the overall
impact on growth is not likely to be severe.
• Domestic spending is the key driver –
consumer demand has accelerated, and
investment spending not likely to slow
dramatically, despite a series of policy
tightening measures.
• Inflation has soared on the back of food
and energy costs, but core inflation is still
very subdued.
Global economic and investment prospects
• US is in recession now and the other major economies are
slowing down.
• Inflation concerns are largely misplaced, and rate hikes by ECB
would only make growth prospects worse..
• ..but the Chinese economy is well-placed to weather the storm
(good news for Australia)
• The US Federal Reserve now understands the magnitude of the
problem, and has responded (aggressive rate cuts, massive
liquidity injections)..
• ..and the economy and financial markets will recover (every crisis,
every recession, every market downturn comes to an end!)..
• ..but we are most unlikely to see a repeat of the kind of investment
returns seen in recent years.
“Maybe I should head into cash
until things settle down?!?”
• Need to get 2 calls right – when to get out, AND
when to get back in
• Macro indicators are often useless when it comes to
timing these things
• Dalbar (2007) Investor performance 20 years to end
2006:
Market return (S&P500) 11.8%
Investors return 4.3%
The difference? Trying to time markets!
“.. there are known unknowns; that is
to say we know there are some
things we do not know. But there are
also unknown unknowns -- the ones
we don't know we don't know."
…”
• What we don’t know…(and may not know, that we don’t know)
? How far US house prices will fall
? How much damage will be done to household balance sheets
? The full impact on US financial institutions’ balance sheets (and
hence their ability to create credit)
? The full impact on household spending and hence the economy
? The full impact on corporate earnings
The cash trap: “I can get 7-8% at the
bank. Why shouldn’t I take it?”
• Market timing is difficult for the best managers, and impossible for the
average person
• 7.25% is either a cyclical peak, or very close to it
• For non-super money, you lose half in tax and the other half through
inflation
• For superannuation money, Cash NEVER builds long-term wealth
• Would you rather lend to the bank or own it? Projected 2008 dividends:
Quoted
NAB
ANZ
CBA
SGB
WBC
Banks Index*
6.0%
6.4%
6.1%
5.2%
6.1%
6.1%
Grossed-up#
8.6%
9.1%
8.8%
7.4%
8.8%
8.7%
Source: MLC Investment Management, ASX. Data as at 27 May 2008.
*Datastream index of Australian Bank stocks. #Quoted dividend yield multiplied by 1.429
Australia in summary
• Reported growth still solid in March quarter, but more recently..
•
•
•
•
•
Retail sales have been virtually flat since end 2007
Credit growth has slowed dramatically
Home loan approvals have plunged
Consumer sentiment has fallen to 16 year lows
Business surveys have shown significant weakness..
• And all this has happened BEFORE the bulk of the impact of
past rate hikes could be expected to hit the economy
• Bright spots?
• Exports
• Huge pipeline of investment spending
• If domestic demand continues to weaken (likely) RBA’s inflation
worries will dissipate, and the next move in rates will be DOWN
Australia: the view in the rear-view
mirror still looks OK..
Australia's GDP growth still very solid..
8
..because domestic demand growth, has
remained very strong..
GDP growth %
Domestic final demand %
8
6
6
4
4
2
2
0
0
q/q%
-2
Q2 1992
Q2 1995
Q2 1998
y/y%
Q2 2001
Q2 2004
q/q%
-2
y/y%
-4
Q2 2007
Q2 1992
..underpinned by a resilient consumer..
10
Annual growth in volumes %
8
Q2 2001
Q2 2004
Q2 2007
Business investment (ex 2nd hand asset purchs) volume terms
Quarterly change %
20
6
Annual change %
10
4
2
0
0
-10
-2
Q2 1995
Q2 1998
..and continued growth inbusiness
investment spending
30
Household consumption
Retail trade
Q2 1995
Q2 1998
Q2 2001
Q2 2004
Q2 2007
Q4 1998
Q4 2001
Q4 2004
Q4 2007
..but the more recent and timely data suggest
interest rates and oil prices are biting
Retail sales growth trend is still
lousy despite May bounce
2.0
Consumer sentiment at levels not
seen in sixteen years
%
140
130
1.5
120
110
1.0
100
0.5
90
80
0.0
70
-0.5
m/m% sadj
60
m/m% trend
-1.0
Jun-05
Jun-06
Jun-07
Jun-08
50
Jan-79 Jan-84 Jan-89 Jan-94 Jan-99 Jan-04
Business confidence and conditions
are deteriorating
NAB business survey points to weaker growth
25 Net balance (%)
20
15
10
5
0
-5
-10
Actual business conditions
Confidence
-15
-20
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
House prices in the English speaking (!?)
economies
300
Real (inflation adjusted) house prices. March quarter 1988 equals 100
US
250
UK
Aust
200
150
100
Sources: Datastream, RBA, MLC Investment Management
50
Q1 1988
Q1 1991
Q1 1994
Q1 1997
Q1 2000
Q1 2003
Q1 2006
Huge pipeline of resources projects
The RBA’s worst ‘miss’ since the start of
inflation targeting
7
Annual CPI inflation (%) - average of RBA's preferred measures
6
5
4
3
2
1
Source: RBA, MLC
0
Q2 1989
Q2 1992
Q2 1995
Q2 1998
Q2 2001
Q2 2004
Q2 2007
Has RBA done enough? (Are borrowing costs
already too high?)
Nominal interest rates the highest since (at least) 1996..
14
%
Source: RBA
12
10
8
6
4
Cash rate
Bank std. variable
2
Bank small/med. business rate
0
Jan-95
Jan-98
Jan-01
Jan-04
Jan-07
Let’s keep the recent volatility in
perspective
7000
ASX300 Index
6500
6000
5500
5000
4500
4000
3500
3000
Source: Thomson Financial Datastream
2500
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Some questions…
• Do you know your own tolerance for risk (the ‘sleep-at-night’
test)?
• Do you know your financial goals and needs (both near term
and longer term)?
• Do you understand what kind of investment returns are
achievable and sustainable over time?
• Is all of this embodied in a financial plan produced by an
appropriately qualified financial adviser?
If the answer is ‘yes’ to all of the above, then nothing that’s
happened in markets recently should cause you to do
much at all!