The recovery year

At the start of 2009, fear of a complete financial meltdown was rife. There was doubt as to whether the massive and unrelenting stimulus and financial rescue efforts put in place around the world would work, and many were talking of a re-run of the Great Depression. As a result, share markets and other assets continued to plunge in March.

However, the key message from governments and central banks in most countries was that they would do whatever it took to head off depression and restore asset prices. Budget deficits in some countries were pushed up to 10% of GDP and several central banks moved beyond near zero interest rates to embark on ‘quantitative easing’.

And it worked! Just when it seemed that all hope was lost, the gloom began to lift in March. Shares bottomed, credit markets unseized, commodity prices started to rebound, bank losses started to recede and the ‘green shoots’ of economic recovery started to pop up. Talk of a false rebound was common. However, as the green shoots turned into saplings and the recovery in share markets continued, it became apparent that the massive worldwide economic stimulus had traction.

But while growth has rebounded, underlying inflation pressures have continued to slide reflecting the massive amount of global spare capacity. As always, inflation is a lagging indicator.

Similarly, unemployment and private sector credit are also lagging indicators. Unemployment has increased to around 10% in the US and Europe, although there are signs that it is close to topping.

Perhaps the biggest surprise over the last year has been the Australian economy. It has managed to avoid recession and then has had a surge in unemployment, despite widespread fears to the contrary. Australia is about the only advanced country to havehad positive GDP growth over the last year. This can be attributed to solid export demand, a sound financial system and the rapid and massive economic stimulus. Australia has yet again proved itself to be the ‘lucky country’. Reflecting this, the Reserve Bank of Australia (RBA) has been one of the first central banks to start raising interest rates.

Emulating the growth rebound, listed growth assets have rebounded in value, as shown in the following table.

• The key winners over the last year have been Asian and emerging markets generally (with gains of around 55%), commodity prices (with metal prices up 80% and gold up 30%), Australian shares and corporate debt.
  
• Global shares have increased in local currency terms. However, for Australian investors the gains have been wiped out by a sharp rise in the value of the Australian dollar (A$).
  
• Cash and government bonds have been poor performers, with the latter dragged down by a rise in yields from low levels as fears have subsided.
  
• After holding up reasonably well in 2008, unlisted property returns fell sharply in a lagged response to credit problems and the collapse in share markets.
  
• By contrast, Australian housing saw positive returns in response to the first home owners boost, the earlier collapse in mortgage rates and the boost to confidence.

As shares are the dominant investment in most super funds, this all translated into a recovery for investors.

The key lessons of the last year were that counter cyclical macro economic policy measures do work, that just as the cycle goes down it also goes up, and that markets always bottom just at the point of maximum gloom.

Outlook for 2010

In direct contrast to the doom and gloom of a year ago, the outlook for 2010 is reasonably bright. Sure, the aftershocks from the global financial crisis – such as high unemployment, periodic debt blow-ups (Dubai, Greece, etc) and constrained bank lending – will linger. But as 2010 progresses, the global recovery is likely tobecome increasingly self-sustaining. In this regard, the key themes of relevance for investors for 2010 are likely to be:

1. A self-sustaining economic recovery. Leading economic indicators point to continued growth over the year ahead. But most importantly, signs that labour markets are starting to turn the corner – notably in the US – suggest the recovery is on its way to becoming self-sustaining. In other words, fiscal and monetary policy has primed the pump and the private sector will now take over. 2010 is likely to see global growth of around 4% (up from 0.8% in 2009, which primarily reflects the late 2008/early 2009 slump).