What's likely to happen in investment markets this year?

Written by Kate McCallum, Multiforte

This is a key question right now as investors seek to better understand the economic backdrop to their financial decisions. 

As always, it’s a tricky one to answer – and we’ll look in a moment at our snapshot of the views of a range of various market analysts and economists. Most of us realise that it’s difficult to accurately forecast market behavior. And you may also know that research suggests that trying to predict market movements and time your investments in or out contributes less than five percent of returns.

The key driver of investment returns is asset allocation, delivering approximately 85 to 95 percent of investment returns. Which is why we focus on asset allocation as a key part of our five-step investment process. And why we apply proactive asset allocation methodology to enhance the long-term performance of our clients’ portfolios. 

It’s interesting to review market trends. It’s wise not to rely on them.

If you would like to know more about how you can improve your investment outcomes, please email Kate or Tony or call on 02 8209 1607. 

Market snapshot

We hear many different commentators providing perspectives on the current market situation and their outlook for the year ahead. Based on our analysis of their views, we have developed an overview of four key themes from 2010, an outlook for 2011 and possible implications for investors.

4 key themes from 2010

A lacklustre Australian sharemarket

The Australian sharemarket underperformed its global peers in 2010, posting low overall share price gains – despite steady economic growth and healthy Australian corporate balance sheets. 

So, why did Australia underperform? Several suggested reasons are: 

• Australian earnings are relatively more expensive than overseas given the movement in the exchange rate and this has encouraged global investors to look elsewhere. 
• Interest rates in Australia are relatively higher and rising, thanks to aggressive monetary tightening by the Reserve Bank of Australia. Described as the most aggressive in 20 years, this has significantly impacted stocks exposed to consumer spending. 
• The strong Australian dollar, which gained around 12 percent against the US dollar in 2010. This negatively impacted the profitability of a number of Australian companies as the value of their overseas earnings reduced, and their domestically produced goods became less competitive in the export market. 

Global sharemarkets recorded strong gains

There has been much recent discussion about markets drifting sideways over the past 12 months. However, apart from China, Australia and France, nearly all other major sharemarkets have experienced high returns over the past 12 months, with markets in the US, UK, Hong Kong, Korea, Singapore, India and Germany all recording strong double digit returns. Notably, the US is no longer considered to be in recession, the corporate sector is in good shape and consumer spending is improving.

Euro-zone debt crisis

Europe continues to be vulnerable to government debt and funding crises, and its growth prospects are subdued. 

The major concern is that the high government debt levels in Greece, Ireland, Portugal, Spain and Italy (often referred to as the PIIGS countries) could threaten the viability of the whole Euro area. The major EU countries (led by Germany and France) have arranged a number of emergency funding measures that should help give highly indebted countries more time to implement tough spending cuts and tax increases, which should bring their debt levels under control.

The rise of the tiger

In contrast to the economic fragility in the US and Europe, Asian economies have been growing strongly. In fact, the Chinese government is implementing policies to slow economic growth and constrain inflation. Despite these policies, China's economic rise looks to have many years to go. It will continue to industrialise and modernise and millions of people will continue to move from the poor rural areas into more productive cities. Due to Australia's substantial supply of minerals and other natural resources to china, we are well positioned to benefit from this expansion.

Outlook for 2011

The 2011 global outlook is for around 4% growth, with the positive effects of the global recovery and Asia’s industrialisation to be weighed up against the dampening effects of government and household debt issues in the developed economies. 

Risks to economic recovery

Even if underlying growth in 2011 meets market expectations there are many risks to economic recovery. These include: 

• In Europe, the national debt problems are a continuing cause for concern – particularly if these problems were to spread to the core Euro countries or futher afield to the UK and US.
• Meanwhile, the US could start to experience rising inflation if the US Federal Reserve continues unnecessary stimulus and in this environment, they would be likely to tighten monetary policy before the economy is on a firm footing. 
• Asset bubbles could develop in Asia as they import a very supportive US monetary policy (as the currencies are pegged to the US Dollar) at a time when they are trying to slow down their economies to ease inflationary pressures. 
• Chinese inflation is approaching 5% and this is also a concern as their policy response to this may have broader ramifications, with the potential to be particularly nasty for Australia. 

The Australian economic and sharemarket 

The outlook for the Australian economy is strong for the next couple of years, with economic growth expected to be around 4% in 2011. This view is supported by several factors including:

• The expectation that unemployment will continue to decline as more labour resources are absorbed into the mining sector and the anticipated investment boom in this sector begins in late 2011. 
• The recent upgrade to Australia’s terms of trade, which are now expected to be around their highest ever level in the near term. The income surge flowing from this will quickly flow throughout the entire economy with workers, corporations and the government all benefiting. 

However, a word of caution. As investors saw in 2010, there can be periods where economic strength and investments can vary significantly. 

Implications for investors 

The outlooks for the Australian and US economies are improving and this should provide support for asset markets in 2011. Meanwhile, growth in Asia, Europe and Japan is likely to slow. The two key risks in this outlook relate to policy – will China be able to manage its inflation without undermining its medium-term growth, and how successfully will European authorities deal with the sovereign debt crisis? While growth prospects appear brighter than six months ago, volatility has also increased and is likely to continue throughout 2011. 

Disclosure and Disclaimer

The material above is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.