The Big Issues for 2002
18 December 2001
The Big Issues of the Past Year
Last year we sought to identify the big issues for 2001. We can claim a reasonable degree of success with the economic 'in' list represented by issues such as 'easing of monetary policy', 'recession' and 'soft landing/hard landing'. On the economic 'out' list we had issues such as 'tight fiscal policy', 'robust economic growth', 'technology bubble' and 'dot.com mania'.
- We also thought 'Telstra 3' and 'superannuation' would have been 'in' issues in 2001 given a Federal Election. However, these issues were pushed largely into the background of the election campaign by the 'left-field' issues of the year - terrorism and security. We thought 'fund manager power' would have received more attention in 2001. However the power exercised by fund managers in allocating assets was a key background issue in 2001, and this will remain a focus in coming years.
Two of our 'left-field' issues - escalation of tensions in the Middle East and failure of a large corporation - did occur, but fortunately had limited financial market impact.
The Big Issues For 2002
If 2001 was the year when talk of recession dominated, year 2002 will be the year of economic recovery. In Australia, the issue is more about the speed and breadth of economic expansion as opposed to recovery from recession experienced in other parts of the globe. In Australia, strong growth in housing activity will be the key driver of overall economic expansion in the first half of 2002.
- But what will take the place of dwelling investment as the growth driver in the second half of 2002? At this stage we would business investment to take the reins accompanied by a degree of inventory re-building. Export growth should strengthen in the second half of 2002 but will be offset by firmer growth in imports.
- The Australian economy is expected to remain a global out-performer in 2002. Economic growth is expected to accelerate to 3.3% in 2002, from an estimated 2.2% pace in 2002. Current survey projections estimate that the growth pace for the Australian economy in 2002 will be around double the pace of economies such as the US, UK and Euro-zone.
- Australia will continue to nervously watch the progress of major economies in securing economic recoveries. The jury is currently divided whether the US economy will power or splutter out of recession. However, there are encouraging signs that the US economy is already on the road back, with orders improving and inventories being pared back. The massive monetary stimulus lays the groundwork for solid economic recovery in the second half of 2002.
- A potentially "hot" issue in 2002 will be market concentration and the impact on competition. In 2001, mergers, acquisitions and company failures have led to increased concentration in a number of industries, especially airlines and telecommunications. Consolidation has also been active in the mining sector.
- Over 2002, we would expect to see increased interest in industry issues such as concentration, competition, regulation and pricing. Industries such as airlines, financial
- services, media, retail, healthcare and telecommunications will face scrutiny from the government, regulators and financial analysts. The focus will vary from industry to industry. For instance regulatory issues will dominate in the media sector with competition and pricing issues of concern in financial services and telecommunications.
- Turning to the sharemarket, the focus has already started to shift away from defensive-type stocks to those that rely on firmer economic growth. Defensive-type stocks - where earnings are relatively less sensitive to changes in the economic cycle - have dominated attention over 2001. Defensive stocks particularly benefited in the immediate aftermath of the September 11 terrorist attack.
- Global cyclical stocks - where earnings and thus share prices are relatively sensitive to changes in the global economic cycle - are already attracting selective interest by investors. While it is right for investors to focus on improved conditions in 6-9 months time, it is still early days in terms of the focus on stronger global economic growth. Global-cyclicals (such as resources, and globally-orientated building material companies) will attract greater attention by investors in early 2002.
- Domestic-focussed cyclical stocks (building materials, paper and transport) have been in demand by investors in recent months, anticipating further improvement in the Australian economy in 2002. Interest in domestic-cyclicals is expected to wane in early 2002 at the expense of growth-reliant companies (such as small industrial stocks) and global-cyclicals.
- Biotechnology companies are also receiving greater attention. The recent re-weighting of the Nasdaq 100 index saw the inclusion of a number of biotechnology and healthcare companies at the expense of computer-related technology companies. In Australia, an index of 12 major biotechnology companies, the Biotech12, has risen 29% over 2001 so far. Biotechnology is a sector that has given promise of being the 'next big thing'. Year 2002 may be its year.
One factor that is more a watchlist than an 'in' factor is strength in asset prices, particularly housing. Generational low interest rates together with first home owner grants have fuelled robust growth in new dwelling activity as well as demand for existing dwellings. Across Australia, growth in established house prices is the highest in twelve years. The Reserve Bank is hoping that price growth has peaked. First home owner demand has been largely satisfied while higher rental vacancies will weigh on investor demand in 2002. But growth in house prices will remain a factor to watch. Low interest rates and rising house prices can generate fear by potential borrowers of "missing the boat". This fear factor may further serve to support demand and prices.
Issues That Remain "In" For 2002
- One issue that is never too far from the spotlight is oil prices. A relatively high level of oil prices early in 2001 was one factor serving to hinder economic recovery. Oil prices softened over 2001, as lower demand by consumers outpaced attempts by producers to reduce output.
So far, oil producers have been successful in preventing oil prices from falling too far. If oil prices settle in a US$20-25 per barrel range then this would be regarded as a positive outcome for both consumers and producers. However, more often than not, oil prices either have undershot or overshot the desired target band. It seems that whatever happens with oil prices, there are potential implications for the domestic and global economies.
The "Out" List
- In Australia, recession fears surfaced in March, following news of a contraction in the economy in December quarter 2000. The drop in output was largely a one-off development associated with the introduction of the GST. However there was the clear risk in early 2001 that Australians could have talked themselves into recession.
- Australia avoided recession in 2001 but the US and Japan did not. While recession will still be a key talking point in 2002, the focus will be more in the past tense. In the US case, analysts are even questioning whether the recession has already ended with attention shifting to the nature of recovery. Japan is a different case, however, and recession is likely to prove very much an 'in' issue over most of 2002.
- As mentioned above, with global recovery now anticipated, defensive-type stocks are losing favour amongst investors. Investors are expected to shift focus to growth and cyclical-focussed companies as economic recovery takes hold overseas. But with global economic recovery still an expectation rather than a reality, defensive stocks still have not slipped too far off the radar screen.
- Rate cuts were 'in' over 2001. In Australia, interest rate cuts will remain on the agenda over the first quarter of 2002. However, approaching mid year, policymakers will be looking to turn off the monetary policy taps. Historical comparisons of lows for interest rates will become an 'out' issue. We expect that the cash rate will end 2002 around 4.5%, compared with a low of 4% expected early in 2001. The magnitude of rate hikes will depend on the nature of global economic recovery and the broadening of the domestic expansion.
Technology was seen by some as a new paradigm, ushering in higher productivity and economic growth. Indeed, technology has changed the world in a number of ways. But the technological revolution has been like revolutions in the past such as railroads and consumer products. New industries created new opportunities and led to a spurt in economic activity. But all new industries, such as technology, go through a process of maturation. Strong firms survive, weak firms fail and new industries are absorbed into the existing economy. The term 'new paradigm' is on the 'out' list for 2002. It will resurface when the 'next big thing' comes around with the associated hoopla about implications for the economy.
Issues That Remain "Out" For 2001
- The 'dot.com' revolution is now part of history. The dot.com companies that remain are those with a specific niche. The surviving 'dot.coms' are those that add value for consumers or businesses.
The 'Left-Field' Issues
There are always those events or issues that are unexpected but serve to shape fortunes of economies. In year 2002 it was the September 11 terrorist attack and the war on terrorism. In 2002, the threat of war or new terrorist threats will remain a very real concern for individuals, businesses and governments alike. Some have also mentioned the risk of deflation. Fears of deflation appear overdone, but a convincing rebound in the US economy is required to remove deflation as a potential economic concern. The potential for failure of a large financial institution or corporation always receives a guernsey as a risk factor in the economic environment. Foreign exchange markets also require monitoring. The US dollar remains strong, despite problems plaguing the US economy. If the US dollar strengthens markedly over 2002, then this could result in action by major economies to check its appreciation.