Praemium

Big Picture

Investors can do well in tougher times

6 Dec 2013 90 month(s) ago

“tough”SMSF investors need to consider the possibility that the Australian economy will not adjust to the end of the mining and capital investment boom. If the adjustment is slow and weak, then the way to make sound returns will change.

“tough”
Australia has avoided a recession for over 20 years and largely emerged unscathed from the GFC. Investors got hurt, but the wider economy survived. That leaves investors, and financial advisers, with very little experience of bad times in the wider economy, although there have of course been some very bad times in the investment markets.

It is possible to do well in investment terms when the economy is not doing well, but a defensive approach needs to be taken. Some types of companies and investments do well in bad times, and that should be the focus.

Here is a graph of Australia's economic growth:

ScreenHunter_546-Dec.-04-12.02

The growth after the GFC has been desultory. Australia is growing more slowly than the United States, largely because of a drop in the terms of trade. To some extent this is just a economic accounting adjustment, but there is is no doubt we are about to get, if not poorer, certainly less rich:

 

ScreenHunter_544-Dec.-04-12.00

That drop in the terms of trade will eventually have a negative effect on the $A. It suggests looking offshore would be a good play. But the process of adjustment will be difficult and many businesses will fail. There may not be a recession, but there is likely to weak growth. Investors can prepare for that, but itmust be done in advance. When it is happening there are usually much fewer options.

Modest expectations are also crucial. The stockbrokers' maxim remains as true as ever. "Bulls can make money, bears can make money, but pigs become the bacon."

It is likely to be more a medium term phenomenon. In the short term, the economy is being revised up, if anything. JP Morgan is pointing out that Australia's current account deficit has widened, although it is increasing its forecast for GDP:

Although the export and import volumes data printed more or less in line with expectations, the revisions to the prior quarters should result in net trade adding 0.7%-pts to growth, slightly more than our forecast of 0.6%-pts. The composition of the trade data was in line with our forecast, with the modest surplus in merchandise trade (A$0.1 billion) overshadowed by a A$2.7 billion deficit in tradable services.
Australia’s income deficit increased by A$700 million in 3Q, the result of a similar-sized decline in income received from equity and investment fund shares. The more interesting component of today’s investment data was found in the financial account, which revealed that offshore demand for Australian government debt bounced back in 3Q, with the offshore sector buying an additional A$9.8 billion of government paper in net terms, the most since 1Q12.

What happens to the Australian economy does not occur in isolation. Citigroup has this assessment of the global economy:

"As 2013 draws to a close, the global economy looks to be exiting the slowdown of the past three years and entering a new phase of modest recovery and growth. Global real GDP growth measured at market exchange rates looks poised to strengthen, from about 2½% this year to roughly 3¼% next year, with further modest increases in 2015 and 2016. But even if this relatively good news materializes, substantial spare capacity (particularly in the advanced economies) is likely to persist. Yet what is revolutionary about 2014 is that the likelihood of severe downside tail events, which could paralyze the global economy, seems to have diminished significantly (though not disappeared). Granted, the euro - area is still work in progress, China presents meaningful question marks, Congressional gridlock in the US could still throw sand in the federal fiscal wheels and geopolitics can always surprise. But, enough progress has been made that all of these issues seem less threatening today than 12 months ago"