Dirk Morris, CEO, CIO BT Investment Management
As 2008 draws to a close, it has turned out to be the worst year for financial markets that I can remember, and a lot worse than I expected. The ASX 200 looks like it will be down close to 40% for the year while global markets have performed much the same In contrast, the Australian economy has held up better than expected, with unemployment barely rising and most companies only feeling the impact of the world slowdown very late in the year. The huge amount of global deleveraging that we are seeing has had most impact on the economies with large financial sectors, particularly the US and UK.
As we move into 2009 the level of pessimism is deepening and most expect it to be another tough year. It is possible, however, that we will see the reverse pattern to 2008, with markets showing resilience, even as economic conditions are likely to deteriorate. This would not be unusual, especially given the amount of policy stimulus that has already been thrown at the economic crisis and given that all policy makers have expressed willingness to continue on this path. Let’s look at the policy responses – which cover both monetary (or quantitative) and fiscal measures.
Impact of policy responses
First, we now have zero interest rate policies (quantitative easing) in the two largest world economies - the US and Japan - with the UK and Europe looking to be moving rapidly in the same direction. Australian interest rate are moving towards 4% and could go a lot lower. The 40% fall in the A$ is an additional boost that will be very supportive of our economy and markets in the coming year.
What does this monetary easing mean? For the economy, it soothes the pain of deleveraging, by lowering or offsetting, much of the rising interest burden caused by the credit crunch. In countries moving to quantitative easing, it means the central banks are actually buying back from the market the debt securities that no one else wants and quantitatively forcing up the supply of money. With inflation still positive (ie negative real rates of interest), this is a big incentive for consumers and business to start spending again.
If we are moving into a true deflationary crisis for the economy, where low interest rates have limited impact, then it is important to see fiscal policy fill the void left by falling demand. To date, the fiscal responses we have seen from across the industrial world have been encouraging. Unlike the 1930s, governments do understand the need to let the budget position move into deficit during down-cycles. Further US fiscal support is likely in Q1 with the arrival of Obama and his new team.
Bad economic news, but perhaps good news for markets
These policy impacts will, however, take time to offset the negative momentum that was allowed to build up in the later part of 2008. For that reason, I would expect further bad economic news, especially here in Australia, where we have lagged this cycle. Ironically, while the economic news will probably get worse, the chances of a market rebound are improving. In financial markets, cash is now piling up fast, with individuals and institutions facing rapid declines in the overall income they are getting from their portfolio. For the first time I can recall, dividend yields are now higher than risk free rates of return in almost every major country and many investors have allowed their equity exposures to fall below long-run targets. I expect this combination means investors gradually look to rebalance back to equities, and that a substantial short-covering rally is likely in the first half of 2009.
How BTIM portfolios are positioned
Our portfolios remain overweight quality large-cap companies and securities (under-weight smaller leveraged companies and sectors). We also remain overweight international markets and have stayed underweight Australian equities (the falling A$ has really helped this strategy). Assuming the world economy does respond to the "wall of money" stimulus coming from governments globally, then it is likely that, here at BTIM, we will start to add to Australian equities and the smaller, leveraged companies in the New Year, and trim international equities and cash.