Question: What does one of our Investment partners think about 2012?
Answer: “Australia: Better than elsewhere but facing headwinds”. Russell Investments, a key investment partner of KeyInvest, is a global fund manager with enviable resources and an outstanding investment record spanning many decades. For their 2012 economic and investment outlook , including forecasts for the equity markets and interest rates.
There are two perspectives on the outlook for Australia. The first is that the economy will be under pressure from weaker commodity prices and export demand, and from a very large fiscal tightening – the government’s plan to deliver a modest fiscal surplus by 2012/2013 implies a fiscal tightening equal to 2.6% of GDP.
Furthermore, the two-speed economy divide will grow larger if the Australian dollar remains above parity.
The other perspective is that Australia is still likely to be the strongest of the developed economies. The surge in mining investment shows no sign of slowing down – the latest survey shows that mining companies intend to increase investment spending by 70% in the year ending June 2012, taking the total spend to 5.5% of GDP. The latest survey by Consensus Economics shows most forecasters expect GDP growth of 3.5% in 2012 following 1.6% growth this year.
We suspect that there is some downside risk to the 3.5% consensus 2012 GDP growth forecast even under our central scenario that the euro-zone holds together, the US posts modest growth and China slows moderately. The two-speed economy theme has hit harder than most analysts expected and we suspect that will be the case next year also – Australian GDP growth of 2.5-3.0% seems more likely under our base case.
The alternative scenario of a euro-zone collapse and ensuing financial crisis would obviously imply a weaker Australian economy and potentially a recession. But Australia should be much better placed to weather a global storm than other economies. A global crisis would again see the AUD drop sharply, potentially below 70 cents. The Reserve Bank, with the official rate at 4.25%, has the ability ease monetary policy much more aggressively than any other central bank and the government could quickly reverse its plan to bring the budget back to surplus. The mining investment boom would continue given the long-term nature of most of the projects.
Australian share market returns are likely to be in the high single digit range and we expect the S&P/ ASX 300 to finish 2012 at around 4,500. Valuations are attractive with the P/E ratio at 11 times, price to book value at 1.7 times and the dividend yield at 4.75%. Our composite value index has the Australian market at near one standard deviation undervalued. The market has the potential to move higher if global concerns ease. Our central scenario for subdued US economic growth and ongoing concerns about euro‑zone stability will keep the local market in undervalued territory.
Australian government bond yields at under 4% are expensive relative to history. A subdued global growth outlook, RBA interest rate cuts and declining local inflation pressures make a sell-off unlikely in 2012. We expect 10-year yields to end 2012 at around 4.0%.
The RBA’s two interest rate cuts so far have taken monetary policy from mildly restrictive to broadly neutral. Interest rate markets are pricing in a further 125 basis points of cuts that would take the cash rate to 3.0% by the end of 2012. This amount of easing seems unlikely barring the euro-zone collapse scenario, but another couple of 25 basis point rate cuts seem likely.
The Australian dollar has downside potential amid weaker commodity prices, slower export demand and RBA interest rate cuts. We look for the AUD to end 2012 between 80 to 90 cents.
Assumptions:
Investment return is 7% p.a.
$6,000 School costs is in today’s dollars and inflated at a rate is 3.5% p.a.
Total investment period is 16 years i.e. 10 years accumulation with 6 years of annual draw downs for school fees
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