Investment Background Briefing – 29th Feb 2016
What did not happen?
- Sometimes the real news is about the stuff that did not happen. Over the weekend the G20 club of the major economies held its latest meeting in Shanghai but did not make any cohesive statement about specific steps that should or would be taken to boost the current slow rate of world GDP growth.
- While such inaction may not be unexpected, it is surprising that it came after concerted pressure from both the International Monetary Fund and the OECD over the course of the week in the run-up to the G20 meeting.
- The IMF over the decades has been a force for conservatism in fiscal policy worldwide, but its Managing Director, Christine Lagarde (herself a former Finance Minister in the right of centre Sarkozy government of France), last week urged the G20 to take bold multilateral actions and a more coordinated policy response to boost faltering global growth as turbulence on financial markets threatens to derail the recovery. This implied IMF support for more fiscal stimulus, which has not yet been accepted by all of the G20.
- In the absence of any coordinated action the IMF has revised its forecast global real GDP changes down from 3.6% p.a. to 3.4% p.a. for 2016 and from 3.8% p.a. to 3.6% p.a. for 2017. The good news is that these are still positive but the margin of safety from recession has decreased and that is what worries the IMF.
- At the same time, the OECD, which has been arguably more fiscally conservative over the years, said that the largest economies urgently need to find new ways to support demand amid a deteriorating outlook for global growth.
- By pitching these calls to the G20, the IMF and OECD were in effect asking the politicians to break a pattern of behaviour built up over the last thirty five years (since the advent of Reagan and Thatcher) and stop worrying about debt and deficit and start borrowing more to invest in pursuit of longer term productivity gains and real economic growth.
- Given the extent to which they have educated their electorates to be concerned about debt and deficit, the democracies among the G20 are not in a position to readily respond with increased fiscal stimulus in the form of more spending on infrastructure.
- The non-democracies among the G20 may be in a better position to do more. China’s Finance Minister, Lou Jiwei, indicated there could be a larger fiscal deficit agreed after the annual meeting of the national legislature starting on March 5.
- The Governor of the People’s Bank of China, Zhou Xiaochuan, said that China’s economy would continue to grow at a moderate to high pace and contribute to global growth. He said that the PBOC has room for further monetary action by cutting interest rates and that the government planned to increase spending to head off any sharp slow down.
- The democracies are stuck with relying on monetary policy even though its effectiveness is diminishing. They have moved through several phases since the crisis of 2008. First came cuts in interest rates to near zero levels, followed by quantitative easing. Monetary stimulus has mainly fed into financial asset prices rather than a resurgence of growth in goods and services. Cutting interest rates and flooding the banking system with liquidity has not stimulated consumer or business spending enough to ensure anything more than the tepid growth rates achieved so far and those now forecast by the IMF.
- The lack of an alternative now means that the developed democracies are pressing on with ever more innovative monetary stimulus. This now includes negative interest rates in Europe and Japan and we now have the Federal Reserve contemplating the need for them in them in the USA.
- Moreover some countries are heading in the other direction on the fiscal policy front. British Chancellor of the Exchequer, George Osborne, warned just days ago he may make further cuts in public spending in his annual budget on March 16. Japan is planning a 2017 sales-tax increase. German Finance Minister Wolfgang Schaeuble rejected fiscal stimulus just prior to the G20 meeting.
- Meanwhile U.S. budget policy continues to be a contest between Congressional Republicans and Democratic President Barack Obama. This will not get any easier in this election year. It may not be any better in 2017 under President Trump or Clinton.
- The European Central Bank has signaled a possible reduction in its deposit rate from the current minus 0.3 percent as well as an increase in the pace of quantitative easing at its meeting on March 10.
- For its part the G-20 simply said that “monetary policies will continue to support economic activity and ensure price stability, consistent with central banks’ mandates”
- World real GDP growth will continue but at a lower than usual pace. This is fundamentally good for growth asset
- China will provide enough monetary or fiscal stimulus to avoid a hard landing. This will avoid a negative shock to world growth but may not be enough to provide much of a recovery in oil, coal or iron ore prices.
- In the major developed democracies, there will be continued reliance on monetary policy stimulus for some time to come. This will include low or negative interest rates. It will also continue to push some stimulus into financial asset prices rather than into real economic activity.
- Both short term cash and long term fixed interest yields are likely to be low for some time, offering little, if any, return above inflation.
- Even though equity markets will have underlying support from ultra cheap money, they will be prone to short run sell-offs whenever there is a recession or deflation scare. The lack of additional long term fiscal policy stimulus in the major developed democracies will ensure that from time to time we have such scares, with equity market prices falling between 10% and 15% at times.
- Not all sectors of the equity markets will be equally vulnerable. The sectors which supply manufacturing such as the energy and mining sectors will continue to be vulnerable to declining commodity prices.
- As well major banks world-wide will be prone to increases in bad debts in some corporate sectors and the highly leveraged nature of banks will magnify the effect of this on earnings and dividends. Investors in banks need to ensure that the prices they pay for the stocks have already factored in loan loss effects as well as the margin squeeze that they suffer when interest rates are very low. At this stage the current PE ratings of the four major Australian banks appear to have factored these in.
Implications for investment portfolios
- Build portfolios founded on growth assets which are liquid, continuously priced, including shares in companies, which have a dominant position in their industries and are well managed by proven operators.
- If investing directly in equities, reduce exposure to the energy and mining sectors and do not increase exposure to the major banks at current prices.
- If investing via funds, move into funds with more diversified equity portfolios that are less like the index and also those that have a higher weighting in cash which will provide them with the ability to take strategic advantage of periods of equity market weakness.
Planning Perspective Gold Coast Pty Ltd is a Corporate Authorised Representative of Madison Financial Group Pty Ltd | AFSL No. 246679 |
ABN 36 002 459 001 http://www.madisonfg.com.au
This information is of general nature only and neither represents nor is intended to be specific advice on any particular matter. We strongly suggest that you seek professional financial advice before acting.