By Stephen Dabkowski
Global Markets Editor
The Age

Notes from a speech given to investors and buyers at Kensington on Tuesday November 16.

In many ways 2004 has been the year of uncertainty. Would interest rates rise? Would the US economy recover? Can the Australian economy continue to grow as quickly as it has? What would happen to the property market?

Now some of those answers are becoming clear and that means there is a lot to look forward to in 2005.

Interest rates are still expected to rise a little further in 2005, but by the middle of next year it will be clear that process should be over. The US economy in recent weeks has shown it is now picking up a head of steam. That’s why the Dow Jones has been racing ahead. In the last quarter the US economy grew at more than five per cent. And finally, despite all the doomsayers especially in my industry (the media), the property market hasn’t collapsed. In fact in certain pockets, where quality product has been in demand, the market has remained strong. Property has been patchy in 2004. But investors are creeping back into the market, but only for the right stock. Some sectors of the market will continue to struggle, while others will continue to enjoy buying interest.

On the Australian economy, while consumer spending might slow a little and there are signs that people are now repaying debt, other elements of the economy should pick up the slack, such as export and investment. Most analysts are saying the economy should continue to grow at levels of 3.5 per cent plus next year, which still puts Australia in the top bracket of the world’s best performing economies.

But there are some dangers:

1. Currency markets.
There has been a great deal written recently about the similarities between Australia and the US. Both just returned incumbent, conservative governments. Both were allies in the war in Iraq. Howard and Bush are close friends. But it may be the differences between the two countries, especially economically, which could be telling in 2005.

The US has gone deficit crazy. The twin deficits - budget and current account - are starting to spook financial markets. Vice President Dick Chaney recently said deficits don’t matter. President Bush remains committed to more tax cuts. Social security costs blowing out. Federal Reserve Chairman Alan Greenspan recently raised concerns about the deficits.

By contrast, Australia has a healthy budget surplus, which only last week was speculated as being $1 billion better than expected. Yes Australia has a current account surplus, but recently has been racking up monthly trade surpluses.
The US economy is only now emerging from slowdown, Australia has been a consistent economic performer. That means our interest rate base is much higher.
As a result the Australian dollar is going up and the US dollar going down. How far that trend continues will determine whether economic stresses emerge. Economists are widely predicting the Aussie dollar could break through 80 US cents, which is uncomfortable territory for exporters, especially manufacturers.
In addition, the falling US dollar already is causing global stresses. Head of European central bank called strong euro ‘brutal’. France and Germany two weeks ago reported quarterly economic growth of just 0.1 per cent.
Currencies are also rising across Asia. Central banks, especially in Japan, intervening hard to contain currencies rises. How long can those stresses continue? Japan growth is still slow at 0.1 per cent last quarter.
World economic isn’t yet consistent; it doesn’t need a currency crisis.

2. China – can it continue its growth?
China remains the key. How important is China? One interesting statistic is that each year at the moment, China to sustain its industrial growth needs to find an extra 44,000 megawatts of power. How much is that? It is the equivalent to Australia’s entire annual electricity consumption. No wonder the demand for raw materials is so strong, driving up prices.  China’s making a brave effort to slow its industrial growth by squeezing credit growth, yet its still growing at 8 per cent.
Some things to watch out for in the future include Taiwan’s elections on December 11 that could promote the pro-independence movement and create tension between US and China.
There is also the issue of what happens when China drops its currency peg with the US.

Despite this I remain of the view that China won’t even have a landing, let alone a soft landing. The amount of international investment and infrastructure spending will ensure the Chinese industrial machine will continue to grow, propelling the economy forward, especially as we near the 2008 Olympics.

3. Interest rates
The good news for Australia is the higher the dollar, fewer interest rates rises expected. That’s because the high dollar is naturally constraining on economy, meaning there is less need for the Reserve Bank to act. Perhaps two quarterly rate rises are expected in early 2005 to continue to ensure consumer spending levels in Australia remain under control.

There are some other good signs in terms of the interest rate outlook. Confidentially, J P Morgan has just done an analysis which shows that for the first time in two years people are not drawing down on their mortgages, they are in fact repaying debt. That should have some effect in slowing domestic demand in 2005, which will also make RBA happy.
In terms of the dangers, if the Reserve Bank is seen as being too cautious and not acting now, that might require more significant rate rises early next year to curb domestic growth -  but only if spending levels show a major lift-off in the New Year, which is unlikely.

The other danger is that the Australian dollar does a roller-coaster. After initially rising it goes into freefall because financial markets start worrying about our current account deficit and rates need to be jacked up to support the currency. Once again this is an unlikely scenario.

Of course if the housing market reignites, the RBA is likely to stamp down hard. While there is some recent evidence that investors are returning to market, it is unlikely we will soon see a return to boom conditions in the market. It will be patchy, which will be enough to keep the central bank reasonably happy.

4. Oil prices
The world economy is not completely out of the woods with the threat of high oil prices, especially asthe crude price continues to hover around $US50 a barrel. While so far consumer sentiment in both the US and Australia have coped well with the high prices, if they are sustained or continue to rise that that will be more cause for concern.

Summary
Wealth creation is back in vogue. Australian sharemarket are at record highs and Wall Street is taking off as well. Average Australian House prices might be going sideways, but there are still strong pockets of growth in the property where buyer demand is strong. Great quality stock is still in demand. Overall, individuals still feel wealthy.

While consumer sentiment remains at or near record levels, the outlook for the economy remains bright. Finally, Australians seem to be slowing in their accumulation of debt, which will make the Reserve Bank a lot happier. That’s also good news for the outlook for interest rates.

That all adds up to a reasonably optimistic scenario of 2005, when hopefully investors can look forward to more certainty.