The AMP’s chief economist, Dr Shane Oliver says no matter how much economic and investment issues change, there will always be a cycle. In other words history may not repeat but it does rhyme.
But the constrained outlook for the US and other developed countries and the relatively strong outlook for emerging countries, along with the emerging world becoming a greater proportion of global GDP than the developed world, makes this cycle a bit different.
It has significant implications for investors pointing to a strategic bias towards emerging markets/Asian shares, commodities and Australian shares. It also suggests the next big asset bubble may be in emerging markets or related themes – but it has a long way to go yet.
One of the most dangerous phrases in the investment world is “this time it’s different”.
It usually gets wheeled out near the end of a bull market to explain why the bull market will continue forever due to a new era of permanent prosperity or near the end of a bear market to explain why the bear market will continue forever due to fundamentally negative forces such as a day of reckoning being upon us.
And usually when it is uttered en masse it marks the turn in the cycle, and makes those who uttered it look foolish.
So the term needs to be used with caution, but while the fundamental drivers of the investment cycle – such as human psychology, the tendency for economic growth and asset prices to revert to a long run mean and the countervailing force of fiscal and monetary policy – remain alive and well, it does need to be recognised that there are subtle differences in each cycle that make them slightly different.
At least enough to be of relevance to investors.
And there certainly are differences in the current economic and investment cycle that investors need to be aware of.
This was already apparent through the downturn phase with a financial catastrophe the likes of which had not been seen before in the post war period combining with the impact of the earlier monetary tightening, an energy crisis and a normal inventory downturn to result in the first slump in global GDP in the post war period.
Moreover, typical cyclical recoveries have seen the US drag the rest of the world out of recession.
This time around it looks a little different.
Uninspiring conditions in developed countries…
While the financial constraints in the US don’t appear to be stopping a recovery, they will likely constrain it after an initial bounce.
Following the financial crisis, US credit creation is likely to be impaired for some time and US households are likely to be more focused than normal on reducing their debt levels following the slump in the value of their assets.
So notwithstanding the potential for a solid initial bounce as pent up demand is unleashed, the result is likely to be relatively constrained economic growth in the US for the next few years.
This is likely to be reinforced as the US moves towards a greater focus on regulation which will boost the cost of doing business in America.
At the same time, structural problems and poor demographics mean it is hard to see either Japan or Europe filling the void.
And of course most advanced countries will need to deal with very high public debt to GDP ratios which will provide another constraint to growth and a potential source of volatility.
So the overall picture for mainstream developed countries points to relatively subpar and unexciting growth over the next five or so years.
And given substantial amounts of excess capacity in the advanced world combined with subdued credit growth it’s hard to see inflation being a problem any time soon.
Sub-par growth and low inflation mean that monetary policy in developed countries is likely to remain pretty easy.
We don’t expect the US and European central banks to start raising interest rates until the second half of next year and tightening in Japan may be two years or more away.
…but inspiring conditions in the emerging world
The outlook for the emerging world is much brighter.
They are not lumbered with the same debt problems as many advanced countries (see the chart above on showing public debt), tend to have far more favourable demographics and have plenty of scope to boost their own consumption to make up for weaker growth in developed countries and are moving to do just that.
Reflecting this, the emerging world is leading the way out of the global recession with growth in many Asian countries rebounding earlier and much faster than has been the case in the developed world.
But not only is the emerging world leading the recovery, this is the first global economic recovery to occur with the emerging world actually being a bigger proportion of the global economy than the developed world (on a purchasing power parity basis).
While consumer spending is a smaller proportion of GDP in emerging countries, emerging world consumer spending is now equal to that in the US.
This all holds out the hope that the global economy can be less reliant on US consumers.
So while there is nothing new in a cyclical economic upswing, the big difference this time around will be the much greater role played by emerging countries.
What does it all mean for investors?
The greater importance of the emerging world and the constrained, more fragile, outlook in the US and other developed countries has a number of implications for investors.
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