14 July 2012

Here is the seeming conundrum – the USA experienced a near catastrophic financial crisis in 2008. It had a significantly overvalued property market which collapsed as the financial turmoil caused credit markets to freeze. US residential property remains in the doldrums with millions of home owners experiencing “negative equity”, meaning their house is worth less than their home loan. The US unemployment remains stubbornly above 8% where it has been for the past 3 1/2 years. The US Federal Reserve has lowered interest rates to near zero and has embarked on an unprecedented bond buying programme in a desperate attempt to restart the economy and yet GDP growth in the US remains below 2%. In contrast, Australia managed its way through the financial crisis quite well. Our four major banks are among the few remaining “AA” rated banks in the world; our unemployment is in the low 5’s; our GDP outlook is healthy and the RBA has plenty of monetary tools still at its disposal to assist in a future downturn.

Now consider how our two stock markets have fared since the financial crisis. The Dow Jones Industrial Average peaked at 14,164 in October 2007; it bottomed out at 6,627 in March 2009 (a fall of 53%) and has recovered to 12,777 at the end of this last week – a recovery from the bottom of 93%. By contrast, look at the fortunes of the All Ordinaries Index: it peaked in November 2007 at 6,873 and fell to a low of 3,112 by March 2009 (a decline of 55%). On Friday it closed at 4,118 – a recovery of 32%.

So here we have the Australian economy being the “envy of the world” according to our politicians, the US mired in continuing economic problems and yet their stock market has bounced back strongly while we languish closer to the bottom – still 40% off the all time high in 2007. Why is it so?

Clearly investors are more optimistic about the future of US companies than they are about ours. One of the keys is the currency which has hit many of our industrial and service sectors very hard. The (relatively) low US dollar bodes well for its economy and the capacity of its companies to compete globally. A perverse result for Australia is that while many international bond fund managers see Australia as a “good risk” and hence our bonds as an attractive investment, this inflow of foreign funds has pushed up our currency and lowered the prospects for our companies. In other words Australia is seen as having a good outlook for bond investments but a poor outlook for our equity market.

Another significant factor is the energy market. The persistently high oil price has provided an unprecedented potential for gas and shale oil, both of which the US has in abundance. Energy supply has long been the Achilles heel for the US but this could be at an end. Australia also has plenty of energy resources but the implications for our economy are much less dramatic. A third factor is the labour market where the US has a substantial advantage over Australia with its greater flexibility in employment pay and conditions.

A good article discussing the future outlook for the USA was written by Greg Sheridan for The Australian on 12 July. It is entitled “Seven reasons not to write off the US” and is worth a read.