Global economy: hopes and fears for 2014
Presenter - Brian Nash
Merlea Investments Pty Ltd
Australian Financial Services Licensee No. 226415
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Global economy: hopes and fears for 2014
Is the global economy heading for another crash?
Many problems, including too-big-to-fail banks and the growth of a largely unregulated shadow banking system, have
not been adequately addressed. Central banks are unclear about how and when to remove the colossal stimulus they
have provided for their economies over the past five years. These core weaknesses mean it would be unwise to rule
out another financial crisis in 2014.
How will Janet Yellen fare as Federal Reserve chairman?
If inflationary pressure rises as the economy picks up, Yellen will face growing calls to move faster. As a serious
economist and Fed veteran, she has as good a chance as anyone of walking the fine line between scuppering recovery
and letting inflation run out of control. But unwinding QE on this scale is an unprecedented challenge: it seems all but
certain that more turmoil lies ahead
Which of the emerging markets looks risky in 2014?
Now that the Federal Reserve has started to reduce the amount of stimulus it is providing each month, the fear is that
the hot money will leave emerging markets as quickly as it arrived, leaving countries facing runs on their currencies.
The most vulnerable emerging markets look to be those with big current-account deficits, because they are likely to be
the first targets for currency speculators. High on the list would be Brazil, South Africa, Turkey and India .
The biggest risk of all, however, is China. China is slowing down after its debt-fuelled recovery from the last recession.
A hard landing in China would have severe global ramifications.
Global economy: hopes and fears for 2014 continued
Is the Eurozone over the worst of its tribulations?
Unlike the US and, latterly, the UK, the Eurozone has yet to recover from the recession of 2008-09.
A double-dip recession ended in 2013 but growth is still barely positive and not nearly strong enough to bring down a
joblessness rate of more than 12%. Deflation is already a reality in Greece and Cyprus, while in Portugal, inflation is only
just above zero. Falling prices increase the real value of debt, making it harder for countries to repay what they owe. The
two potential flashpoints for 2014 are the ECB's asset quality review of Europe's banks, and the need for fresh bailouts for
the two most vulnerable countries: Greece and Portuga.
Will Abenomics succeed in fixing Japanese economy?
The burning question for 2014 is whether the first two of his three policy ―arrows‖, spending surge and quantitative easing
on a massive scale – will be followed by the promised third arrow: economic reform. Among other things, the Abe
administration is creating hundreds of thousands of childcare places, in a bid to tempt more mothers into the workplace and
harness the power of what he calls womenomics. A series of overseas trade deals, including the ambitious Trans-Pacific
Partnership, are also likely to lead to the opening-up of new sectors of Japanese industry to competition. There's a clear risk
markets will lose faith with the debt-burdened Japanese government in the meantime (ratio of debt to GDP: 246%). By the
end of 2014, we will have a much clearer idea of whether Abe's gamble has paid off.
Will Oil prices surge
It will begin quietly, and will bring together many of the same factors that led to the previous repricing, which began in
2003. Spare capacity, the cost of the marginal barrel, and the continued decline of the cheap barrel will all confront a new
upswing in global demand. The upswing in demand will largely be led by a return to global growth, even as renewables and
the power grid will become the main avenue for global GDP. Oil's next repricing will not be as dramatic in percentage terms.
But the road to $150 oil begins in late 2014.
Top 10 Economic Predictions for 2014
Top 10 Economic Predictions for 2014
US growth will slowly speed up.
The European recovery will proceed, but at a
very sluggish pace.
3. China‘s growth rate will be sustained.
4. Other emerging markets will also perform a
5. Unemployment rates in the developed world will
6. Commodity prices will go nowhere and inflation
will remain a low-level threat.
7. The Federal Reserve will start scaling back its
stimulus, while other central banks will likely
wait or provide more stimulus.
8. Fiscal headwinds will ease.
9. The US dollar will strengthen against most
10. There will be more upside risks than downside
risks facing the global economy.
Outlook for non oil commodities
Demand was relatively subdued in 2013,
constrained by weak OECD growth and
slower Chinese growth.
Rising incomes and ongoing urbanisation in
the developing world will underpin mediumterm demand growth in industrial raw
The current price of many foodstuffs does not
accurately reflect the future demands on this
industry. Particularly as the world moves
towards 9 billion and continues to increase at
a totally unsustainable rate of 3 million
people a week.
Expect the price of many commodities to
increase in 2014
Inflation receding worldwide, but still a concern in some
In the near term, monetary policies designed to
achieve a desirable level of inflation will continue
to counteract the deflationary pressures of a highdebt world still recovering from a deep financial
Key drivers of U.S. consumer inflation generally
point to higher-but-modest core inflation in the
1.5%–3% range over the next several years. In
parts of Europe and in Japan, deflation remains a
The potential for higher inflation may force a
number of countries – including Brazil, Turkey,
India, and Indonesia – to raise interest rates in
2014. At a time in which growth is already slow,
monetary tightening would represent insult to
injury for financial assets
Central bank near-term bias
With economic momentum picking up in 12/13 but inflation
remaining below target, we expect the BoC will maintain a
neutral policy stance in the near term.
The Fed will continue to taper asset purchases in 2014, although
stronger forward guidance points to the fed funds rate
being held at its current level until late 2015.
With unemployment continuing to fall toward the BoE’s 7%
threshold, we expect forward guidance will be strengthened to
assure markets that the Bank Rate will not be raised in 2014.
Weak inflation continues to highlight the need for exceptional
monetary stimulus, and we expect rates will be held at current
levels. The ECB continues to emphasize its willingness to act
further if the economy fails to improve.
The RBA maintained a mild easing bias in December, but
Governor Stevens has noted that the effect of further stimulus
would be limited.
Continued exchange-rate volatility
Global growth differentials between emerging and developed countries, normalization of monetary policy in high-income
economies, ongoing guided official intervention and leadership transition in core emerging market jurisdictions are some of
the primary near-term drivers of foreign exchange flows.
Attractive interest rates and earnings potential will trigger repatriation flows into USD assets. Top-tier currencies (CAD, MXN &
BRL) will suffer a soft tone in the first quarter of the New Year.
Europe is in a nascent economic recovery. However, we project a weakening tone for the core currencies (EUR, GBP) and toptier regional emerging-market currencies (RUB, TRY) as US economic and market strength drives capital flows back into the
USD and interest rate differentials weigh on the EUR.
The Asian currency landscape will be dominated by resurging CNY appreciating forces and JPY weakness versus the USD.
Competitive realignment forces may weaken those regional currencies aligned to the JPY. The THB will retain a negative tone
until political risks and uncertainties dissipate.
The consumer is key to the economic outlook
Stronger growth in 2014
The US economy is expected to gain momentum
We have upped our 2013 GDP estimate to 1.9%.
Momentum in late 2013 supports our view of
stronger growth in 2014. We maintain our forecast
at 2.6% with risks to the upside.
Government spending will support economic
growth in 2014 for the first time since 2010.
The US Fed started scaling back its bond buying
programme in January 2014. This will lead to a rise
in government bond yields and mortgage rates.
The Fed will employ forward guidance in order to
exert downward pressure on short-term interest
The US will probably not be as much of an engine
for world growth as in previous global upswings,
but amongst the advanced economies, the US will
look strongest with growth averaging around 3.0%
Three main drivers of household spending:
Are Consumers Upbeat and Spending?
• Conference Board:
Latest consumer confidence near 5½yr high.
• University of Michigan:
Consumer sentiment is just below a 6 yr. peak.
Household wealth. Have Americans seen their wealth
• Are households spending more on big-ticket
items? Yes! Purchases of consumer durable
goods accelerated in the last quarter.
The Fed on a Tight Rope
Incoming Fed chair-woman Yellen will be
tasked with finding the appropriate pace of
monetary tightening that continues to
support the economy but prevents surging
A further complication might arise from the fact
that long term interest rates will start creeping up
early while the economy is still trying to walk on
its own. In particular, stronger mortgage rates
could prove to be a thorny issue. Indeed, higher
rates would slow the housing recovery, but it is
uncertain the Fed would want to ramp up
purchases of mortgage-backed securities to offset
the increase once tapering is underway.
PMI at one-year low, as output growth eases sharply
PMI rises to 11-month high, indicating solid improvement
in business conditions:
• Output supported by strong increase in new orders
• Employment growth quickens to nine-month high
• Input price pressures intensify
Equities and Commodities
After big gains in equities in 2013, the onset of US tapering will result in much more modest equity
market increases in 2014
By the end of the year, annual increases in equity
prices will have fallen to around 5-6% in the US.
On the commodities front, we expect increased oil
supply (helped by reduced disruption in key
producers) plus modest demand growth to push
Brent oil prices down to US$104 per barrel in
2014 from US$109 per barrel in 2013.
The picture for most other commodities should be
similar with gradually firmer demand being
balanced by stronger supply and inventories.
Bottom Line for the US Economy
Higher home values and stock prices are driving gains in household wealth.
More hiring would help lift Americans‘ spirits and underpin the consumer purchases that make up
about 70 percent of the economy.
Households are confident that the increase in overall economic activity are sustainable and expect
gains in 2014.
Manufacturing also showed signs of making strides in the new year. The Federal Reserve Bank of
Philadelphia‘s factory index increased to a three-month high in January as sales and employment
National debt: USD$16.5tn and rising; debt to GDP: 106% and rising. This is absurdly
QE to infinity promises currency debasement, rising prices and lower discretionary spending.
Foreigners are buying fewer, and selling more US Treasury bonds.
America‘s future economic growth will depend on its ability to innovate, create, and reinvent the
way it does business. And it will need to meet the growing and evolving untapped demands of an
increasingly challenging global environment
Tapering will be easier said than done, and the stock market is often badly surprised.
Euro zone growth fell back to only 0.1% in the
third quarter from 0.3% in the second.
But the region has emerged from recession and
we have raised our 2014 growth forecast to
The ECB‘s decision to cut its main policy rate
by 25 basis points to 0.25% in November was
a response to a decline in the euro zone‘s
inflation rate to 0.7%, well below its 2%
Deflationary pressures are building in Greece
and Spain as they undergo ―internal
We expect growth in the euro zone to average
1.4% a year in 2015-18.
Balance sheet obstacles to sustained demand.
Europe gets stressed
Europe will begin 2014 with its economy slowly
starting to recover from the recession of the last
few years - but make no mistake, the Euro Zone
crisis is percolating away in the background and
threatening to erupt at the slightest provocation.
Portugal‘s ability to exist - the bailout looks shaky
and Greece can no more pay back its enormous
dent this year than it could last year.
A new Greek debt write off will be needed at
This will likely follow some sort of Slovenian
banking bailout. It is perilously close to that stage
Europe Looks Like Pre-Abenomics Japan
The threat of deflation will hang over much of Europe
for the year ahead and if this starts to threaten the
German economic heartland we may see the ECB
start to engage in more unconventional monetary
activity (basically QE) to boost inflation. Expect stiff
resistance to this in Germany.
2014 could also be the year the bond market finally
gives up on France, as it becomes clear that the
country will not deal with its budget deficit (it hasn‘t
balanced a budget in nearly 40 years) and the bond
market may take fright.
Europe‘s latest unemployment statistics are a horror story
Unemployment rate – youth and total
Europe’s unemployment rate is showing
some signs of peaking at last — but at
12.2% overall it’s horrifically high, and
youth unemployment in Southern Europe is
higher still. Unemployment will remain
scandalously high across the fringes of the
continent and the Euro will spend the year
overvalued as ever – largely due to China
selling its US investments and putting the
proceeds into Euros.
Tempers at home are increasingly frayed
and next year will see more middle class
protests as this section of French society is
absolutely taxed to the hilt (to a higher
extent than even in Sweden).
• There are signs that the European economy is emerging from recession, but the recovery will be slow and
uneven. PMIs they have shown a turn-up in recent months. Also, the positivity enlightened by a rising
EUR relative to the USD has been indicated by some as a 'good' thing - though obviously (as Mr. Hollande
recently noted) not for all as exports hurt
• All-in-all, it seems, as we have seen elsewhere, that equity markets are pricing in a miracle as
fundamentals reflect anything but. Though perhaps, the fact that European stocks and credit are now
down in price on the year reflects an awakening to the solemn realities...
• But the disparity between southern European cities and those elsewhere will widen.
• The price of energy (in EUR) is high, very high, and wearing on spending and margins. This margin
pressure is even more intensified as the region gets close to deflation in asset prices - not good... and sure
enough, the EUR strength (that was apparently a good thing) is crushing export growth
• Domestic Demand and GDP growth is decidedly negative and while second derivatives are heralded as
green shoots, they are most certainly not taking the euro-area out of recession any time soon. This is
weighing increasingly on the population as consumers see their general economic situation and household
financial situation as very weak over the next 12 months...
• Credit is still tight, which will constrain business investment, and while consumer spending has picked up a
bit, French and German shoppers can‘t make up for a lack of demand in countries like Spain, Italy and the
Netherlands, which are still in recession. Meanwhile, some 20 million people in the euro zone are still out
of a job — a record 12.1%. That‘s unlikely to change anytime so.
• What is Abenomics?
• Will Abenomics restore
• Will it succeed?
Everything You Need To Know About ‗Abenomics‘
The 3 Arrows
Expansionary monetary policy
Large scale QE
Flexible fiscal policy:
Japan has increased its debt
No sign of wage growth has
Abenomics key for Japan's economy in 2014
The catalyst for the change has been
prime minister Shinzo Abe and his
recovery programme, dubbed
On some measures, Abenomics has
already been a huge success: while
the Nikkei has rallied, the yen has
devalued sharply, helping Japanese
exports, which reached a three-year
high last autumn.
GDP growth has been less dramatic
and the trade deficit has widened,
partly due to the costs of importing
energy following the Fukishima nuclear
Will Abenomics work?
• The first arrow is flying towards the target.
• The second arrow is in the wrong direction.
Macroeconomic policy alone may help end deflation in the narrow sense but cannot
• The third arrow is important but has not been shot.
It is not clear where the third arrow is aiming. Need to focus on fewer reforms e.g:
Promote business realignment of companies and create an environment that
encourages innovative start-up companies and new businesses in order to improve
productivity and enhance corporate earnings.
Support companies that shift to making proactive moves through decreasing the burden
on corporations by, for instance, providing tax incentives.
Fed Tapering and its Implications for Emerging
• Why the slowdown of growth
in EM and financial pressures?
• Which EM will suffer the most?
• Will some EM‘s experience a
severe financial crisis?
Why slowdown now
Move away from market oriented policies
towards state capitalism
Some laxity in monetary and fiscal policy
as liquidity was abundant, interest rates
too low and credit excesses
End of luck as: China is slowing and
becoming less resource oriented
The commodity super-cycle is over
However slowly the Fed will taper and
exit 0% rates. US bond yields up from
1.6% to 2.9% since May 2013
Traffic stands clogged near Connaught Place, a
central commercial area in the heart of New Delhi,
India. India’s auto sales surged 71.9 percent in
November, according to data the Society of Indian
Some EM‘s have stronger macro, financial and policy
fundamentals and some have weaker ones
Weaker ones include countries with large current account deficits, large fiscal deficits, falling growth,
rising inflation, socio-political protest and upcoming elections
Weaker group includes: India, Indonesia, Brazil, Turkey, South Africa, Ukraine
The INR depreciated by around 25%
during the ‘taper tantrum’ reflecting
concerns around India’s twin deficits
problem, weak growth and high
inflation. However, the trade balance
has improved sharply by about onethird over the past 3 months.
Negative real policy rates in
Indonesia. Deteriorating current
account deficit reflects both an
adverse terms of trade and
monetary stimulus. Inflation risks
and strong credit growth putting
pressure on the IDR despite policy
Will some EM experience a severe financial crisis?
But the weaker EM have some negative risks
Ugly policy dilemma:
If you tighten monetary policy to avoid
currency free fall and inflation, you kill
growth and damage banks/corporations. So
tight money is not credible.
If you loosen monetary policy to boost
growth, there is the risk of an inflationary
free fall of the currency and risk that
foreigners will not finance your external
If you thus loosen monetary policy you may
lose the nominal anchor of the economy and
thus cause a free fall
So damned if you do and damned if you
We expect capital inflows to gradually recover starting in the current
quarter, albeit on a lower trajectory
Developing nation stock markets have only been this
cheap five times in the past 20 years, analysis suggests
This markdown in projected capital flows reflects
both pull and push factors. The fundamental
underpinnings of EM growth have deteriorated,
making them somewhat less attractive to foreign
investors. Moreover, rising global interest rates in
anticipation of a Fed exit have compounded
domestic weaknesses in EMs.
Increased country differentiation by investors should
reward economies with strong fundamentals, but
continue to put pressure on vulnerable economies.
Private capital in-flows to EM economies are forecast
to fall in 2013 and 2014.
China, hard landing or soft landing?
• Will China experience a soft
landing or hard landing?
• China‘s growth is unbalanced
• Reforms will be slower than
optimal and desirable as
leadership is divided.
Local governments 'need to refinance debt'
Chinese local governments will issue
new debt in 2014 to repay old loans,
since a large amount of local
government debts will mature in the
near term, said analysts in Hong Kong.
Based on National Audit Office data,
this year and early 2015 will be the
peak repayment period for local
This could be done through bank
financing or issuing corporate bonds.
Hopefully, they will choose bonds,
because liquidity is tight on the
mainland and that's expected to
Banks will have to issue preferred
shares first to prop up their capital
bases, if they are financing these
In the past years, local governments have borrowed heavily
to finance infrastructure projects. If defaults on debt
repayments occur, experts say it could cause a confidence
China‘s growth is unbalanced and unsustainable
China's economy still faces many difficulties,
such as high local government debt, increasing
reliance on "land finance" and inadequate
liquidity risk controls. Meanwhile, shadow
banking products are rising fast, and there is
severely unbalanced supply and demand in
some regions' real estate market.
First-tier cities continued to lead rises last
month, with the prices of new homes in Beijing
and Shanghai surging over 20 percent from a
year ago, but Liu said the trend has been losing
New loans denominated in foreign currencies hit 584.8 billion
yuan in 2013, representing a year-on-year decrease of 331.5
Economic growth rebounds, but outlook softer
The country is now in the spotlight because
a crisis in China would probably send the
world into a new crisis.
China‘s growth is unbalanced and
unsustainable: too much savings,
investment and exports; too little private
The key question at this stage is whether
China would be able to manage a gradual
deceleration of its economy, a soft landing,
or, fall into a sharper slowdown, a hard
The latest set of macroeconomic indicators
show that Chinese authorities are succeeding
at managing a soft landing. Many analysts
have expressed doubts about the reliability
of Chinese data, but overall it is accepted
that they can be taken as a proxy of the
direction of the economy
After years of very high growth, the government is
managing a controlled deceleration.
Reforms will be slower than optimal and desirable as
leadership is divided
China's leadership is serious about reigning in
credit and will probably allow a sharper growth
Having re-accelerated over the summer of 2013,
growth momentum declined again in the fourth
quarter of 2013 as the withdrawal of stimulus
measures began. Industrial output growth eased
and so did investment and government spending.
Exports also decelerated. Business sentiment
indexes for manufacturing and services softened.
Risk of a harder landing than the consensus
expects (7.5% to 8% growth). Growth may slow
down to 7% in 2014 and below 6% by 2015.
Will the reforms be strong enough to rebalance growth
The new leadership appears to be aiming for that. Major reforms that are rumoured to be
on their wish list include:
• Relaxing price caps on natural resources: then electricity rates and other production input costs would
increase. That would shift investment incentives away from low-wage, resource-intensive sectors such as steel
and cement manufacturing and toward higher-wage, resource-efficient sectors such as high-end technology
manufacturing and financial services.
• Relaxing interest-rate controls and increasing financial market competition: Current regulations
cap the interest rates that China‘s state-owned banks pay on consumer savings and lock competing
alternatives out of the market. Chinese citizens deposit their money in state banks at very low returns, and
that gives the banks access to cheap capital, which they then loan out to state-owned enterprises at very low
• Relaxing the household registration system: Under the current system, Chinese families have a permit
to live in a certain district. If the best job opportunities are elsewhere, people can certainly move, but they will
have to do so as illegal migrants. They will not have official residency permits or access to social services in
the new location. Freeing up this system would allow for more labour mobility, particular rural-to-urban labour
• Levelling the playing field for private capital: Under the current system, state-owned enterprises enjoy
preferential access to bank financing, government contracts, and so-called ―strategic‖ market sectors such as
rail, telecommunications services, electricity, and natural resource development, such as oil and gas
International market summary: The most important forces that will shape
the global economy
Global monetary easing is drawing to a close::
More than 500 interest rate cuts have occurred worldwide since June 2007.
The payoff: Faster growth in 2014 – 2015
Who is the newest emerging country? It is the United States!
Energy revolution = It will have a profound impact on aviation, travel, tourism, manufacturing and the dollar.
OPEC and Russia to be losers.
U.S. to regain competitive advantage. Outsourcing becomes much less attractive.
Capital of innovation = iPhone, Google Glass, Tesla, 3-D printing, Robotics, Genomics.
Emerging countries now dealing with ―growth pains‖:
3.5 BILLION PEOPLE will move from rural areas to cities in the next 5 to 10 years;
$20 TRILLION to be spent on infrastructure to support this massive migration.
MORE THAN 50% of global GDP growth in the next 10 years will STILL come from emerging economies.
Brace for more serious exogenous shocks:
Middle East, Asia, global terrorism, cyber-war – all pose great threats to business.
Yet few firms perform stress tests to evaluate their vulnerabilities.
Australia's Economic outlook for 2014 is sobering, but that
shouldn't lead to pessimism
Australian Performance of Manufacturing Index improved by 1.5
points in October, rising to 53.2
The latest Australian Industry Group Australian Performance of Manufacturing Index (Australian PMI) was broadly unchanged in
December, at 47.6 points (seasonally adjusted). This marks the second consecutive month of contraction in the Australian PMI
(50 points marks the separation between expansion and contraction), following a short-lived period of expansion (September and
October) immediately after the Federal election.
The latest seasonally adjusted Australian Industry Group Australian Performance of Services Index (Australian PSI®) moved 2.8
points lower to 46.1 points in December.
RBA lowers 2014 GDP forecast
As the global economy continues to
recover, next year Australia will be left
With 22 years of consecutive growth
Australia was the envy of the developed
world, however many analysts have turned
bearish on the economy amid a number of
The most prominent concern has centered
on the slowdown in the country‘s once
booming mining sector, caused by
declining demand from its major trading
Many worry that Australia‘s non-mining
sectors will not be able to ‗pick up the
Tourism arrivals from China are surging
November contained more sombre news for
Australia‘s tourism industry, when the ratio of
annual arrivals to departures fell to its lowest
level since November 1985, driven in part by
a slump in inbound tourists from China .
The year to November 2013 was a record for
outbound and inbound tourism. A record 8.65
million Australians holidayed overseas over
the year – a 159% increase on 10 years ago
(3.34 million). However, this was partly offset
by a record 6.44 million inbound tourists
arriving in Australia over the year – a 37%
increase on a decade ago (4.71 million).
As always, South East Asia (particularly
Indonesia and Thailand) remains by far
Australia‘s favourite holiday destination,
receiving 228,000 visitors in November, or
31% of Australia‘s total departures over the
Inflation behaving as expected - Allowed RBA to put rates on hold
Inflation well within target at 2.2%.
Traded inflation is beginning to rise.
Domestically generated inflation pressures are
Slower wages growth on the back of
softer labour market.
RBA very comfortable with inflation outlook.
The central bank says the impact of those rate
cuts are being observed in rising asset prices.
Australian companies and consumers may finally be throwing off
the shackles of doubt and fear
Survey of business by Dun & Bradstreet for the first quarter
of 2014, published Tuesday, has returned some of the best
readings on business activity for over a year.
Some two-thirds of Australian businesses say they‘re more
optimistic about growth this year than last, the survey
showed. Expectations for sales, employment, selling prices,
capital investment and profits have all turned up at the
That suggests the flow-through effects of cheap credit are
finally starting to emerge, months after the Reserve Bank
of Australia cut interest rates to a record low of 2.5% last
Add recent data showing racing housing prices and faster
credit growth, and there‘s room to rethink the outlook for
2014. If business is feeling better about the future,
consumers may soon follow. Spending and hiring make for
a stronger economy.
The housing market – an improving story?
As the market enters 2014 and as values rise across each capital city, the rate of growth will vary greatly.
The main challenges in 2014 are likely to be the impact of a forecasted higher unemployment rate, affordability
constraints for the more price sensitive sectors of the market (particularly in Sydney, Melbourne and Perth) and
whether any regulatory changes will be implemented by APRA and the RBA to cool the near-record high levels of
Where are we in the economic and stock market cycle?
We are in the expansion
Sector Rotation Model
Where to Invest in 1st Quarter 2014
Financial (reduce property trust and bank stocks as they are becoming
Consumer cyclical (reduce exposure durable – non durables)
Australia faces the challenge of managing prosperity
What could derail the American recovery? We believe the most significant threat to U.S. economic growth
is inflation, which would cause long-term rates to spike. Wage inflation is not a problem, as
unemployment is still relatively high. At 1.5%, core inflation is well contained today and looks to be so for
the foreseeable future, while the velocity of money, a primary driver of asset inflation, remains subdued.
More broadly, structural issues across the euro zone continue to create considerable headwinds to more
robust growth: money growth is slow, bank loans have declined, and unemployment remains at more
than 10% for the region, with youth unemployment even higher at 23%.
For some time we have been saying that the Australian economy sits in a soft patch and is likely to
remain there over the next 18 months at least. The economy is transitioning from a post-GFC stimulus
and the second round of mining investment boom led growth to one of a more broadly-based growth
The non-mining-related industries are still suffering from the aftermath of the GFC. The overriding logic
has been to cut costs. Nonetheless, by being financially conservative and deleveraging following the GFC,
many businesses have rebuilt their balance sheets. But they will not invest significantly until capacity
constraints emerge, and that is 18 months to 2 years away.