MELBOURNE AUSTRALIA 24 January 2007 – As the Australian market marches inexorably on to ever higher levels, we take a moment to pause and take on board the comments of a couple of right old bankers – former US Treasury secretary Lawrence Summers and the current President of the European Central Bank, Jean-Claude Trichet.
In a story compiled by Bloomberg News they warn that the excellent stock market returns experienced in the US and Europe (and Australia) may not last for long.
Summers warned, “It’s worth remembering that markets were very upbeat in the early summer of 1914… financial history demonstrates that the biggest liquidity problems always follow the moments of greatest confidence.” He finishes off by saying, “Complacency can be a self-denying prophecy.”
Willem Buiter, a former member of the Bank of England Monetary Policy Committee said, “Current risks are ludicrously underpriced, at some point, someone is going to get an extremely nasty surprise.”
Given all the risks that are still present in the global economy it is fair to say that especially in the US, the market has roared into the sunset just at the point where corporate profits are starting to slow. Will investors be quite so happy to pay these prices for stocks when earnings are slowing or at a standstill?
Domestically, the market is still going from strength to strength. The magic formula is still no closer to being brandished a fraud. When commodity prices rise, the resources companies do well and more money pours into the economy because, well, the Chinese still need the stuff.
When commodity prices fall, money still pours in because, well, the Chinese still need the stuff, only other sectors of the market get some relief from higher costs making them happy too.
The only downside? Inflation and a potential interest rate rise. Although a survey by Bloomberg indicates that most economists believe today’s Consumer Price Index figure will come in at only 0.2% for the fourth quarter, it still places inflation way above the Reserve Bank of Australia’s comfort zone of 2-3% at 3.6%.
Scott Haslem, chief economist at UBS Australia Ltd in Sydney told Bloomberg, “We really haven’t had enough time for the full impact of three interest rate increases to work their way through the economy. It’s more likely that inflation will be heading down a bit, given the data we’ve had on economic activity. The Reserve Bank has room to remain on hold for now.”
However, even if the CPI does remain at this elevated level on a Year-on-Year basis, economists are still forecasting that the RBA will not increase rates at the first meeting of the year in February.
The falling crude oil price during the last quarter of 2006 and its continued fall into 2007 may be just enough to convince the RBA that the current high – relatively – inflation rate could be reduced in this quarter as less money is spent on fuel.
However, the question then becomes what will happen to those savings? Odds are that it will just be spent on other items. An increase in spending on these items should do nothing more than increase the pressure on inflation in other areas of the economy. And of course, there is nothing to say that crude oil prices won’t rebound from the low USD$50’s back to levels seen no more than three months ago.
There is certainly one person who is still convinced that oil will more than double from today’s price. However, he is a little sketchy on the timeframe. Jim Rogers of Quantum Hedge Fund fame said, “Within the context of the bull market, oil will go over $100. It will go over $150. Whether that is in 2009 or 2013, I don’t have a clue, but I know it’s going to happen.”
The inflation bull market may not have run its course yet.