This, in a nutshell, is what is troubling the Aussie economy, and to some extent the rest of the world. From the Financial Review:
‘Businesses are holding back on investment because they are still wearing the scars of the global financial crisis, according to Treasury secretary John Fraser.
‘“People need to be convinced … that the economy, both domestically and internationally, is growing,” he told an audience at Citi’s annual investment conference.
‘“They are naturally sceptical, and so they should be. They want to see real growth. It’s been eight or nine years — it’s been a very long cycle, but it’s a cycle.”
‘A lack of non-mining investment and slow wage growth, even as more jobs were created, were the two issues “befuddling” Treasury and policy makers, he said.
‘Mr Fraser said the most telling comment from his liaison with businesses came in Sydney when an executive told him they were not investing because “the scars of GFC are far greater” than they realised. “People are so rattled and wounded by the global financial crisis, it will take time for it to come back,” Mr Fraser said.’
Mr Fraser’s reference to a ‘long cycle’ is correct. That is, we are still slowly emerging from the last downturn. The problem is that too many of us are looking for some sort of return to normal.
What they don’t get is that this is normal. It’s what happens after a huge debt build up and bust, with the bust cut short but the intervention of central banks and governments.
You can’t get a return to ‘normal’ of you haven’t cleaned out the errors and malinvestments of the past.
In the US, the Federal Reserve is only just starting to unwind its years of quantitative easing. (The first asset purchase program got underway in 2009.)
Thanks to massive official intervention in the global economy, this current cycle will be more drawn out than any other in history.
And thanks to the massive ‘scars’ inflicted on investors and businesses because of the GFC, there will be constant fear about ‘another’ crisis.
But here’s the important takeaway. While there is widespread fear about ‘another GFC’, it won’t happen. You simply can’t have a major bust if none of the pre-conditions that caused the first bust are in place.
The preconditions to look for are both fundamental and psychological.
Fundamentally, there is little evidence to suggest that asset prices are losing touch with reality.
Commodity prices are still well below their recent highs. Global property prices are below their highs from 10 years ago, and equity prices, while stretched in major global markets, are not particularly expensive when compared to bonds.
The extraordinary intervention in assets markets has created extraordinary conditions in financial markets. But that doesn’t mean everything’s about to blow up.
Psychologically, we don’t appear to be in peak boom (close to bust) mentality.
Yesterday, I took a quote from a Bloomberg article in which a money manager suggested that it would be ‘almost irresponsible not to’ have a buy the dip mentality.
This is a little worrying. It tells me the US market is stretched. A decent correction is probably looming. But given the US market’s strong momentum, it could still be months away.
But is a credit crisis style crash likely?
For that to occur, you really need to see a coordinated global asset market boom — especially in property.
Well, this is the biggest asset on banks’ balance sheets. When property booms and then busts, it infects the global financial system via its impact on bank balance sheets.
In Australia in 2008, bank share prices came under huge pressure in large part thanks to a commercial property market bust. The residential property market was mostly unscathed.
In case you’re thinking the banks are dangerously exposed to Aussie residential prices now, keep in mind that interest rates are likely to stay at record lows of 1.5% for some time.
As I have pointed out previously, in the early 2000s the US Federal Reserve raised interest rates 17 times (in 25 basis point increments) before the property market busted.
Given the environment we’re in and the prolonged nature of this cycle, there is no way the RBA will perform a similar tightening.
In the minutes of its October meeting, released yesterday, the RBA basically said it’s happy to remain on hold, despite the rest of the world moving toward interest rate normalisation.
‘Members observed that moves towards higher interest rates in other economies were a welcome development, but did not have mechanical implications for the setting of policy in Australia.’
That’s why the Aussie market has put in a strong rally recently. It sees a decent economy and a central bank on hold. It’s the classic goldilocks combination that the Aussie market loves. Which is why I think you’ll be seeing new highs in 2018.
Editor, Crisis & Opportunity