Both sides now seem to agree on the need for increased tax revenue and spending cuts. While the risks are high the most likely outcome is a compromise involving:
A 1.5% of GDP fiscal drag in 2013 would be manageable as it’s not much bigger than the 0.9% fiscal drag that applied this year. Three other factors are likely to support US growth.
Firstly, the US housing recovery is gaining momentum with a survey of home builders’ conditions rising to its highest level since 2006 and pointing to a sharp rise in housing starts and construction. The US housing recovery is likely to add 0.75 percentage points to US economic growth in 2013.
Source: Bloomberg, AMP Capital
Secondly, the ending of Operation Twist (i.e. selling short-term bonds to buy long-term bonds at the rate of $US45bn a month) is likely to be replaced by the purchase of long-term bonds using printed money to the tune of $US45bn a month boosting QE3 to $US85bn a month. The additional monetary stimulus is likely to further boost US growth.
Thirdly, if as appears likely the fiscal cliff issue is resolved, business investment that had been delayed because of worries about it will likely rebound. All of this suggests that US growth could pick up to a 2.5% pace next year.
Chinese economic growth appears to be bottoming around 7.5%. Indicators for industrial production, retail sales, investment and business conditions have all bottomed or improved in the last few months. A stabilisation in China should be positive for growth elsewhere in the region.
Finally, while we are pushing into the fourth year of the global expansion and the 3-5 year cycle suggests risks, the reality is that none of the normal excesses that mark the end of cyclical upswings – high inflation, labour shortages, excessive debt levels – are present.
Overall this suggests global growth is on track for around 3% growth this year ahead of a modest improvement to around 3.5% growth next year. Not brilliant, but not the disaster many have been fearing and factoring into share markets.
A stabilisation and modest improvement in global growth next year should provide a reasonable backdrop for earnings growth. At the same time, shares remain very cheap relative to bonds as indicated by a 6% or so gap between equity yields and bond yields, which is a measure that provides a rough guide to the risk premium of shares over bonds. This is well above the levels that prevailed before the GFC and also post-GFC averages.
Source: Bloomberg, AMP Capital
At the same time, monetary conditions remain very easy globally and investor sentiment towards shares has recently fallen back to near levels that normally set the scene for a rebound. As a result, while shares may still have a few more wobbles in the near term, we remain of the view that shares will end the year higher and continue to move up, albeit with occasional setbacks, next year. That said I think I’ll sleep with my fingers crossed on December 20 and 21.
Australian shares will also likely benefit from a rebound in global shares. They are cheap relative to bonds (see the last chart), will benefit from a likely further decline in official interest rates by the Reserve Bank and will gain from improved sentiment regarding China.
One dampener though remains the strong Australian dollar, which continues to make life tough for Australia companies and which makes it hard to be confident that Australian shares will outperform global shares.
Dr Shane Oliver is the head of investment strategy and chief economist at AMP Capital. Please note that this article is intended as general information and not as investment advice.
