Alan Kohler's 2010 market outlook

By Alan Kohler, Eureka Report

We have now finished a decade - appropriately known as the noughties, or naughties - when Wall Street has had its worst 10-year performance in history, worse even than the 1930s, and when the Australian sharemarket has outperformed the rest of the world by 70 per cent.

Normally you would say 'Buy America, sell Australia' because first, bad decades on the US sharemarket are normally followed by very good ones, and second, because the Australian sharemarket has never outperformed the world for more than five years, let alone 10.

But these are not normal times, in case you have forgotten - and it would be understandable if you had - we have just been through the worst economic crisis since the Great Depression, an event economists call the Great Recession.

The US, UK, Europe and Japan are all still mired in debt, and although their economies are recovering as they float on a wave of liquidity and fiscal stimulus, and their sharemarkets are anticipating a rapid snap back in profits, disappointment looms.

The other reason things are not normal is China. This has also been the decade when China arrived and changed everything for Australia.

That, and the lack of a dot.com bust in Australia, is why the Australian sharemarket outperformed the rest of the world from the beginning of the decade.

A tussle of two powers

For Australia, the economy and the market, 2010 is likely to be all about the tussle between the two great powers, America and China - one declining, one rising. And this is as much about America's self-destruction as China's relentless, ruthless progress.

The extent of reflation now being attempted by the US has only been tried once before, and didn't work; second, China is America's largest creditor and is single-mindedly pursuing its own interest, and in the process kicking sand in America's face.

The only time such an expansion of money supply combined with fiscal stimulus has been tried in peacetime before was by Japan in 1989, after the collapse of its property and sharemarket bubble. Since then Japan has had 20 years of less than 1 per cent real economic growth, with zero real interest rates. As an economic force - any kind of force at all - it is entirely spent and going nowhere but backwards.

The result of virtually zero growth for two decades is a debt-to-GDP ratio in Japan of 200 per cent. There is no prospect of paying this back and at some point it will become unserviceable. Watch Japanese credit default swaps for clues about when that might happen.

I am not suggesting the United States is in for 20 years of deflation and zero growth (although that cannot be ruled out). But the lesson of Japan is that the easy way out is an illusion.

The result of this year's liquidity-driven rescue of the US economy from the brink of disaster is a combination of excessive liquidity, a likely government debt spiral and national moral hazard on an unimaginable scale.

Moreover, US corporate profits are likely to be disappointing over the next few years because profit margins are at record levels and are likely to shrink. Profit margins are especially high in finance. This reflects unusually low interest rates, central bank subsidies and monopolistic profits. Non-financial margins are also high, because of big cuts in employment, the weak dollar and low contributions to pension funds.

Nevertheless, the only asset bubble likely to burst next year is US Government bonds, although the rise in US bond yields is more likely to be gradual than sharp because America is the dairy cow of its largest creditor, China, to be milked, not slaughtered.

Unease at money printing

Gold, commodities and shares all have further to go and are nowhere near bubble extremes, although shares are likely to correct savagely at some point when profits disappoint.

Some people think commodities are a bubble waiting to burst already, but how can you talk about a bubble when most commodities are well below their record highs? In fact, there is no single market in the world making record highs except gold, US Government bonds, cocoa, and the Sri Lankan sharemarket.

Gold will continue to rise despite its all-time high, because there is now a lot of suspicion about paper money around the world as governments print huge amounts of money. Also, no new large gold mines have been opened in decades and the central banks that have huge gold reserves above ground are less interested in selling than in the past. They are actually buying gold now to diversify away from US dollars.

The oil price is likely to keep rising as well, because all the oil-producing countries have declining reserves, as do the oil companies.

Investment matched by savings rate

Then there's China and its insatiable demand. Many people believe China is over-investing and that overcapacity will cause a crash. That is simply wrong in my view, although I am not suggesting China will never have a recession. The over-investment that is going on as the Government spends its way out of a slowdown, is on infrastructure.

You may have seen pictures of empty eight-lane freeways, which looks wasteful. But that is quite different, in my view, to over-investment in factories, which was the pre-2007 problem.

China's high level of investment is more or less matched by its savings rate. It is true that the savings are due to what we might call negatives - the lack of a social safety net and hoarding of cash by government-owned companies that do not pay dividends - but it is there nevertheless.

The medium-term implications of this year's massive infrastructure investment in China are positive, not negative: it will facilitate future urbanisation and lay the foundations for a consumption boom.

The bottom line for 2010: bet on China, not America. That means bet on Australia - it is in the right place at the right time.

About the author

Alan Kohler is publisher of Eureka Report www.eurekareport.com.au and Business Spectator.

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