And (almost) everything is just as it was a year before. The major economies of the world are in recovery mode, although there are still questions being asked about the longevity and strength of the recoveries, particularly in Europe. Financial markets are trying to figure out what to do next. It wouldn’t surprise me if the same is again true a year from now.

Let me firstly apologise for the fact that this “end of year” missive is being penned three days prior to the end of the financial year. I had travel commitments in any case, but I also need to recover from a severe overdose of Ted Mulry’s “Julia” in the past 24 hours. What, by the way, is wrong with the Beatles?

In sum, the financial year hasn’t turned out to be too bad for investors. Barring calamity in the next few days, the average investor in a balanced fund can expect a return of 10-12% for the year. In the piece I wrote at the beginning of the financial year, I gave a target for the ASX200 of 4500 by June 30 this year. The index passed through that level (unfortunately on the way down) on 24 June, but that forecast is at least still “live”.

While the year has thus been satisfactory in total, all of the joy came early on. Indeed, the market first closed above 4500 on 1 September 2009, so in the year we had two months of solid gains followed by 10 months of grind. As the chart shows, the market thus went from “dirt cheap” in early 2009 to not cheap six months later. But right now, by this measure, it is again looking cheap.

As a result of the recent correction the Australian market is again cheap (forward P/E ratio)

Cheap markets don’t stay cheap forever, but it generally takes a catalyst of some kind to get them moving again. Lately, they have been climbing a wall of worry; about European growth, the possibility of a double dip in the United States, and even the chance of a slowdown in China. European growth has been slow and will continue to be, but the “Greek problem” is very unlikely to derail the world economic recovery. The housing sector in the United States stubbornly refuses to get up off the canvas, but all of the attention is on that and not, for example, on the strength of business capital spending. Chinese slowdowns happen a lot less often than they are forecast.

Despite the “wall of worry”, there have been far more positive than negative growth surprises in the past year. In June 2009, the world economy was expected to grow by just 2% in 2010. Forecast growth is now 3.5%, and every major country, including those in Europe, is doing better than was expected. Just one example: Japan is having an astonishingly good recovery, admittedly from a deep recession. In the twelve months to Q1 2010 it was the fastest-growing developed country in the world. You may not have read about that; good news apparently doesn’t sell newspapers.

What of the year ahead? While we certainly haven’t heard the words “sovereign debt” for the last time, in my opinion the market reaction to these concerns has been overstated. The question that must always be asked is: is this a big enough concern to derail the global economic recovery? I see no reason to answer yes at this stage. Given that markets are cheap right now, they should make substantial progress over the course of the financial year. My target for the ASX200 a year from now is currently 5500, although progress will probably be of the “two steps forward one step back” variety.

Strange Days Indeed
Who could have foretold two months ago that the attempt by the Government to impose higher taxes on the mining sector could become a major reason leading to the downfall of a Prime Minister? While this is not the place, and I am not the person, to discuss the political aspects of this extraordinary development, it does provide an opportunity to reduce the divisiveness of the RSPT debate. I have previously stated my views about this tax and I see no reason to resile from them. There is economic merit in more efficient (and somewhat higher) taxation of the mining sector, and that will presumably be the eventual result. And ‘twere best it be done quickly.

No matter what, mining investment will be the strongest part of the economy for the next year or two, and one of the tasks of macro-economic policy will be managing overall growth while the mining boom goes on. Given that we are starting the year with unemployment at 5.2% (and who could have foreseen that a year ago?), and given that inflation is currently at the top of the Reserve Bank’s target range, this almost certainly implies more interest-rate rises, although not at the rapid pace of recent months. This need not derail the share market, since both share-market gains and the rate rises will be occasioned by continued robust economic growth.

Chris Caton
Chief Economist