The Big Question By Chris Caton - Recovery Or Just A Rally?

Sydney, Australia (PressExposure) May 15, 2009 -- April was another good month for investors. The ASX 200 rose by 5.5%, and is now more than 20% above its 6 March low. The US share market, as represented by the S&P500 index, rose by 9.4% in the month (its best month since early 2000). It is now 29% above its early-March low. The US share market has now risen in seven of the past eight weeks, including a run of six successive weekly rises in the market. Believe it or not, the last time that the US share market rose for six weeks in succession was way back in 1938.

My view has not changed: this is probably the start of a genuine recovery, but one can still not absolutely rule out that what we have seen is "just another bear-market rally". But, as is always the case, investors who wait until they are absolutely sure that a recovery is genuine will miss a lot of upside.

The recovery is out there... somewhere

As I have written before, markets almost always recover before there is one skerrick of good news about the Australian or global economies. But in the last few months, the "green shoots" view has taken greater hold around the world. This view says that there are already a few early signs of life in the major global economies. Chinese growth prospects, for example, are no worse than they were two months ago, and the almost-universal purchasing managers' indexes (PMIs) have come in stronger than expected. (If you don't know what a PMI is, your life is not really the poorer for it.) In addition, an important measure of consumer confidence in the US rose hugely in April; it has risen by more just once in the past six years, and Japan has reported positive growth in industrial production. None of these data points prove that economic recovery is just around the corner, but they are consistent with the view that it's out there somewhere. And, as I have said before, financial markets and economies will begin to recover long before all of the world's financial problems are resolved.

Swines, SARS and September 11

There are, of course, still things to worry about. The latest possible market-mover is swine flu, and who would have predicted that a month ago? There is, of course, always a risk of a serious pandemic, but let me make one point. History suggests strongly that analysts (and markets) tend to over-estimate the negative economic effects of such events. SARS was a big concern in 2003, followed by avian flu in 2004. Both of these had only slight temporary economic and market effects. The same, incidentally, was true of hurricane Katrina, the aftermath of September 11 and the Kobe earthquake, to name just a few. The economic effects are almost always overestimated early on, and what that means is that such events usually present a buying opportunity.

Budget 2009: Swan's ugly duckling?

Of course, since it's May, it's also time to begin the process of anticipating the federal Budget followed, of course, by seemingly endless analysis of it once it has been delivered. In my opinion, far too many trees die each year in this exercise.

That said, this year's Budget will stand out from its predecessors. A year ago, the projected Budget surplus for 2009-10, which is now the first year of the Budget, stood at $3.6 billion. This year, it is likely that a deficit of more than $60 billion, the biggest in Australia's history, will now be forecast for 2009-10. And the so-called "out years" of the Budget will also feature large deficits.

The deficit has "blown out" not only because of the fiscal packages, but also because of the effect of the weak economy on revenues and, to a lesser extent, on spending. This has led to handwringing by many who should know better about the evil consequences of all the debt that will be created as a result of the deficits. In allowing the Budget to go into deficit in an attempt to mitigate the effects of the recession, the Government has done exactly the right thing. The Budget exists to serve the purposes of the economy, not the other way around. While it is true that we will finish up with public debt of $200 billion or higher (eventually), this will be a very small sum (and a very small percentage of GDP) by international standards. There will be no massive burden imposed on our children. Because public debt became a key political issue rather than an economic issue, Australia, to its cost, has been turned into a nation of (public) debt fetishists. We are not the better for it.

Bringing it all together It is true that fiscal policy will have to be carefully managed in the economic recovery (and there will be a recovery, beginning almost certainly before the end of this year). The short-term deficit will have to be wound back, and that will take time. In addition, along with almost every other major economy, we will still have a medium-term fiscal problem, caused by the tectonic shifts in our demographic structure. These shifts mean that, as the years go by, a progressively smaller proportion of the overall population will be working, and “paying for” the pensions and publicly-funded health care of the more mature of us. What this means is that all new expenditure initiatives will have to be vetted closely, and it also probably means that taxes will eventually have to rise.

**Disclaimer and Disclosure This publication has been prepared and issued by BT Financial Group Limited ACN 002916458 who provide investment products. While the information contained in this document has been prepared with all reasonable care no responsibility or liability is accepted for any errors or omissions or misstatement however caused. All financial forecasts and estimates are based on certain assumptions which may change. If those assumptions change, our forecasts and estimates may also change.

Chris Caton

Chief Economist

About BT Financial Group

Chris Caton is the Chief Economist for BT Financial Group. He was Chief Economist at Bankers Trust from 1991 until July 1999. From 1994 to 1997, he was also Chairman of the Indicative Planning Council, which advised the Government on matters relating to the housing industry.

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Press Release Submitted On: May 27, 2009 at 9:34 pm
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