FYI | Aug 02 2006
Only a few months ago it seemed like the 2006 investment story would be simple and straightforward.
After a few months of extreme bullishness, global markets experienced the correction that had become overdue as every cab driver and his dog were threatening to put all their savings in gold, uranium and several other commodities they’d never heard of but that were said would triple – at least – in price over the next few years.
After that (or was it because of that?) we had to confront the inflation scare. Higher prices for commodities had finally caught up with the inevitable, but everything would remain just fine. At least, that’s what the experts told us.
Three months later I have to admit I am not so sure anymore.
One of the reasons is the price of oil.
Is the world underestimating the supportive factors underneath the price of oil?
Well, for starters, ever since oil left the US$30s per barrel zone the global expert community has been slow to catch up with the new reality. It is not that long ago that many a securities analyst still put a long term price forecast of US$35 per barrel of crude oil through his or her sector valuation models.
Most of the world has been in catch-up mode over the past three years and the process is still ongoing with a few experts having raised their price forecasts this week for the next two years. Expect more of them to follow in the weeks ahead.
What this tells me is that inflation forecasts are likely to move higher as well.
However, this is not just about oil. From the US, to Europe, to China and Australia input costs for businesses are squeezing margins. Prices for consumers will have to go up, or profits will come down.
Company profits are already coming down. As pointed out by Merrill Lynch analysts this week, global expectations for corporate profits have now started to fall and it is likely that the process will yet gather pace.
Contrary to what your instinct tells you, this is actually good news. What the world needs right now is slowing economic growth. It will reduce the upward pressure on prices, allowing central bankers to remain on hold, which will take away the constant cloud that hangs over global equity markets.
China will have to slow down too. We all know what this means: even more volatility in the markets, especially on the commodities side.
Under a best case scenario, call it Goldilocks if you want, all this would lead to central bankers keeping their powder dry. While most companies would find the going gets tougher, share markets would still happily add a few more percentages to this year’s tally so far. All in all, that would make calendar 2006 not so bad, a few scares aside.
But that’s not necessarily how it will be.
The public debate amongst economists and strategists at the moment is whether the increased momentum in the economies of Europe and Japan will be resilient enough to withstand a slow down in the US.
It would seem that we all want the answer to be no. Because that will take the pressure off the oil market and reduce demand for Chinese products, both will help to keep the inflation monster contained from now on.
No matter in what way, shape or form the above scenarios develop over the coming months, it will have become clear to anyone that for investors in the share market the going is definitely to become tougher.
Has anyone else noticed that property trusts have been among the outperformers in the local share market for each of the past three months? It has been a while since yield investing was the norm. I think it was more than three years ago, before we all woke up and realised that BHP Billiton (BHP) shares at $9 each were an absolute bargain.
Unfortunately, what seemed like a rather simple and straightforward scenario ahead of us has become less so over the past few weeks. Economists at Credit Suisse, for instance, believe that global economic growth will prove to be more resilient than we all would like it to be.
That would be not so good news.
JP Morgan has been amongst the more bearish experts since early this year. The difference with the likes of Mellon Financial is that JP Morgan thinks the Fed Funds will rise by another 75 basis points still.
Few would think such a scenario would not put the US economy into recession.
A combination of falling corporate profits and rising interest rates would be devastating for the share markets as well. That’s why JP Morgan thinks Aussie shares will underperform their US peers in the year ahead, even though US shares are expected to generate a negative return.
Maybe we should all start sending emails around asking our friends and contacts across the globe to stop spending all our money, every month. Or is it already too late for that?
Till next week!
Your don’t look at me when it comes to not spending all my money editor,
Rudi Filapek-Vandyck
(Supported by the Happy Chappy Four Rob, Chris, Terry and Greg)