Thoughts on the Australian economy and investment opportunities in 2008

The last 5 years have been among the most prosperous in Australia’s economic history. Emma Connors in the AFR December 28 quotes CommSec’s Craig James:

‘Australians are not just doing well, they are doing better than previous generations by a country mile. Once allowance is made for inflation, private sector wealth has doubled in the past 5 years, a result never before achieved.’

The main factors that I see bearing on the Australian economy during 2008 are: (1) The continued dependence of Asian countries on Australian raw materials and food supplies which will drive strong Australian growth in supplying these areas; (2) a subprime-related slowdown or below par growth in the US economy that will moderate global growth prospects but which will create speculative investment opportunities; (3) an inexperienced Labor Party in government which will partially re-regulate labour markets in the face of mild inflationary pressures and continuing strength in the Australian dollar and (4) major new investment opportunities as well as problems presenting themselves as a consequence of the climate change mitigation and adaptation area.

Some have described the conflicts between pressures (1) and (2) on the Australian economy as a tug-of-war between US and Chinese influences on Australia. That is a fairly accurate description but, in broader terms, current developments show the effects on increased economic integration and the one-to-one harnessing of economic events in Australia with those in China and other rapidly developing poor countries. There will be a fair bit of uncertainty so wise investors are building up reserves of cash - a factor contributing towards the credit market slowdown - to jump into opportunities in the face of over-reactions to instability.

Generally I expect that positive factors (1) will outweigh negative factors such as (2) and (3). Thus I anticipate strong continued growth in the Australian economy with Labor Party rule damaging the economy (ex public servant Rudd will soon understand that a barrage of glib slogans is a long way from defining a course of action) but, in the main, the costs will be inconsequential as the Labor Party remains a passive observer of the drama that is currently transforming the Australian economy. The subprime crisis will drive poorer economic outcomes in the US with retreating US consumer demands marginally damaging growth prospects in China. In the main, increased trade with Asia and increased global integration provides protection for Australia against particular nation-based instabilities.

In equity markets it is almost certain that the subprime crisis will provide nasty surprises in isolated pockets – I am obviously wary or property investment and building products companies - as the Australian market faces the prospects of longer-term declines in highly overpriced residential and commercial property. But the US economy is a resilient beast – it will slow a little though I do not expect a recession and speculative opportunities will emerge if panics develop. It is difficult not to remain positive about the Australian resource sector evben though lagged supply effects might cause some easing of commodity prices.

A punt might be that a speculative equity boom might start to develop in firms fostering alternative energy supply technologies in response to anticipated global warming initiatives – Eden Energy (a geothermal spinoff to become Torrens Energy), Geodynamics, Greenearth Energy, Green Rock Energy, Petratherm and Panax Geothermal are the sorts of geothermal energy companies that might bubble from the earth. In practice a shift to increased use of natural gas is likely to be the most significant actual short-term response but there is less 'blue-sky' in this sector.

Many of the sorts of stocks I am looking at now I began being interested in at end 2006. My interest remains in these areas.

Of course the wise guys will stay attuned to possible ripples from the US subprime problem and to instabilities in the Chinese economy. The Chinese market is very likely to take a substantial correction in 2008 providing possible opportunities for buying Australian resource stocks at a discount.

(The usual disclaimers on these last three paragraphs – don’t take my advice, consult a professional!)

Generally then I am very positive about the prospects for the Australian economy in the short-term with continued high growth, a strong currency and more terms-of-trade induced income and wealth gains.

In the longer-term – over the next 20 years or so - I see an enormously strong economic future for Australia with quality lifestyles coupled with good environmental policies and high levels of material wealth. A significant longer-term issue will be the impact of climate change policies on Australia’s export capacity. This is somjething Austrial firms need to reason through with appropriate technological responses. But fundamentally Australia is a society with many options and strength that fundamentally derives from our stable socio-politico-economic system, our generally well-educated population and our immense natural wealth for a relatively small-sized population.