This article has been reproduced with permission from Alan Kohler.
I returned to work last week even more optimistic than I was before I went, and not just because I was still glowing from the Bali sun.
While I was away the market rallied 2 per cent and although it’s looking ‘toppy’ and looks due for a pullback, I think we are now in the situation where buying on the dips is the best idea. The global recovery is on and, as I explained before Christmas, money is shifting back into equities around the world.
So bearing in mind Nassim Taleb’s dictum that “the only prediction one can safely make is that those who base their business on prediction will eventually blow up”, there are five reasons I am optimistic about 2013 without exactly predicting anything: China, America, Europe, Japan and Risk.
To start with the last of those, in my view 2013 will be a 'risk-on' year. Well to be honest this started half-way through 2012 when it became clear firstly that the global economy was recovering and secondly that the European Central Bank, with German support, really would do whatever it takes to keep the euro intact. The Fed was already doing whatever it takes to get the US dollar down, and the Reserve Bank was doing whatever it takes to get the Aussie dollar down (not that that’s working yet).
All of which means the returns from cash are miserable and falling. Time to invest then, which means taking more risk, but not too much – thus, bank shares returned 25 per cent in the second half of 2012.
In my view this trend has just begun. For five years investors everywhere have been more concerned with not losing their capital than with making a return and gradually that is changing; they are moving out along the risk curve. Obviously taking more risk means just that, and the world is not yet a safe place (is it ever?). I think the greatest danger has passed, and while deleveraging will continue to hamper growth there are many positives offsetting that.
Sam Walsh must be the luckiest man alive. Not that he doesn’t deserve to be chief executive of Rio Tinto – of course he does, in fact he probably should have taken over years ago (I’m sure he agrees) – but because he takes over just as China’s economy bottoms and turns around and with $14 billion in writedowns tied to Tom Albanese’s tail. All new chief executives would dream of having their troublesome assets all written off and their main customer on the improve.
The data on China that came out last week contained several positives, apart from the fact that growth, at 7.9 per cent, was better than expected. The transition towards greater consumption and less reliance on investment has continued, with consumption now accounting for 4 per cent of GDP growth in the fourth quarter, higher than gross capital formation (3.9 per cent). Growth in retail sales improved from 11.6 per cent to 12 per cent in 2012 and car sales grew 6.9 per cent (5.4 per cent in 2011). The acceleration in consumption happened because income growth, at 9.6 per cent in the cities, was greater than GDP growth for only the third time in a decade.
So the project of converting China from an export and investment driven economy to one that is based on domestic consumption is intact. Income growth is being helped by the remarkable fact that the working age population actually fell in 2012, by 3.5 million – the first such fall ever.
This brings its own challenges of course. It makes it even more imperative that the Chinese authorities reform the economy to promote the return on capital, otherwise economic growth will stall. The state owned enterprise system is deeply inefficient, as you’d expect, which has never mattered too much while the labour force has been growing so rapidly. As it declines, productivity must rise.
But while the long-term picture is clouded, it’s clear that 2013 will see China’s economy continue to accelerate, which should support the iron ore price – if not at $150 a tonne, then certainly above $120. Happy New Year Sam!
China is recovering and so is the United States, with housing leading the way. The National Association of Home Builders Housing Market Index is at a six-year high and double the level of January 2011. The “prospective buyer traffic” component of the index is at the highest level since January 2006. The median house price is up 10 per cent year on year, as is the volume of sales. Residential construction has bottomed and the vacancy rate is heading down.
Thanks largely to housing, the US private sector is growing at a pretty rapid clip – about 3 per cent if the government sector is removed from GDP calculation. State and local governments are starting to join the private sector in recovery, with only the federal government continuing to shrink. Moody’s expects local and state governments in the US to expand employment by 220,000 in 2013, a huge turnaround from the previous three years of job losses.
Manufacturing has been slow to move, but that seems to be now happening as well. Industrial production expanded 0.3 per cent in December after a rise of 1 per cent in November. But the December number was held back by a fall in utilities generation: factory output jumped 0.8 per cent in December. As for this year, cheap energy is expected to produce a resurgence of US manufacturing.
There’s a lot of talk that the budget deal will create a big headwind, but that seems to be overdone. There are two main elements to the deal that will produce fiscal drag: the payroll tax increase, which will cut
GDP by about 0.7 per cent, and the spending cuts due to be implemented in March – another 0.6 per cent of GDP. That 1.3 per cent of GDP fiscal drag seems large compared to 2.2 per cent average GDP growth since 2010, but as Anatole Kaletsky points out the IMF calculates that US fiscal drag on the economy was 1.3 per cent in each of 2011 and 2012. In other words, fiscal drag in 2013 will be no greater than the previous two years.
That is, as long as the politicians don’t snatch defeat from the jaws of victory by sending the US into default because of the debt ceiling. They have about six weeks to raise the limit, since the government will run out of money on March 1. Surely they will, although as usual it will probably be at the last minute.
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By Alan Kohler - from Business Spectator - 23rd January 2013
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