A year to remember and forget- Review of 2008

09.12.08

2008 is a year most investors would prefer to forget.

Like 2007, the past year has been dominated by the US sub-prime mortgage crisis. But unlike 2007, we are seeing mounting losses, growing panic amongst banks and investors and policy mistakes producing the worst financial/economic crisis since the Great Depression.

During the first half of 2008, there was a perception that the sub-prime mortgage crisis was manageable. Investors considered emerging markets as a strong enough buffer against the problem, so much so that shares were deserted in favour of commodities, pushing commodities prices to record highs. Associated inflationary concerns saw several central banks around the world raise interest rates, including the Reserve Bank of Australia.

These moves to tighten monetary policy proved to be big mistakes as things changed radically for the worse during the second half of the year. US Authorities allowed investment bank Lehman Brothers to fail, leading to the failure or rescue of numerous other financial institutions throughout the US and Europe.

In rushing in with an enormous ‘bank-rescue plan’ the US Authorities inadvertently convinced the world of the severity of the problem. The result – a massive slump in share markets through September, October and November, renewed blow-out in borrowing spreads in money/credit markets, a dive in commodities prices and extreme volatility in currencies including a 35% slide in the $A after nearly reaching parity with the $US in the middle of the year.

Confidence plunged as it became clear that all the turmoil had caused immense damage to the global economy. The slump in world trade and commodities prices dragged emerging countries into the downturn. Recessions in Europe, Japan and the US have now put advanced countries on track for their worst ever post war recession. Australia has stalled in response to the global downturn with falling commodity demand, reduced confidence and loss of wealth exacerbated by rate hikes earlier in the year.

OUTLOOK FOR 2009

There are likely to be a number of key macro themes for 2009:

• Global recession during the next six to nine months. Households in rich countries are yet to reduce their lifestyle debt levels. However, some sort of recovery should start to become visible during 2009/2010. Some conditions for global recovery are occurring currently (falling oil prices, falling inflation, falling bond yields) however others are not (decline in US house prices has not slowed, private sector borrowing rates still high).
• A deflation scare is likely to develop (slump in commodity prices and rising global excess capacity pushing inflation rates negative).
• Global interest rates are likely to fall further and stay low for a while.
• Commodity prices are likely to be weak until late 2009/early 2010.
• Profits are likely to fall sharply in response to the slump in growth.
• It is likely that Australia will at least have a mild recession. Unemployment in Australia is likely to rise to 7 -9%. The cash rate in Australia may eventually be cut to below 3%, and further fiscal stimulus is likely, taking the budget into deficit.

OUTLOOK FOR SHARES

It’s still to early say whether we have seen the end of the bear market in shares. Further falls are possible. However, if global growth starts to recover before the end of 2009, share markets will anticipate this and start to move higher.

OUTLOOK FOR PROPERTY

Average house prices are likely to remain under pressure. Lower interest rates and higher home owner grants will help, however affordability is still poor and rising unemployment will keep potential home buyers on the side lines. Prices for domestic residential and commercial property are likely to fall further.  Listed property may stay constrained in the first half of 2009 by the need for capital raisings and worries about valuations, but better yields should mean 2009 is a more promising year for LPT’s.

OUTLOOK FOR FIXED INTEREST (BONDS)

Bond yields may still push lower as it becomes clear that inflation and cash rates will stay low for a long time. However, given yields are so low it is possible that returns will hold at around 5-6%.

OUTLOOK FOR CASH

Cash is becoming far less attractive as interest rates fall. Cash returns are likely to reach 4% or less in 2009.