Economic review and outlook: Blue skies ahead?

This year saw more worries: Renewed fears about Europe; more US “double dip” fears; weaker growth in the emerging world; US drought threatening higher food prices; and ongoing Middle East tensions.

However, despite the wall of worry it turned out to be a good year for investors. Key themes for 2012 were:

• Soft global growth, but no recession. While global growth softened from 3.8% in 2011 to around 3% and profits were downgraded, both were better than feared a year ago. In other words the falls in share markets in 2011 anticipated the economic slowdown of 2012.
• >Easy money. Slowing growth and benign inflation resulted in plenty of monetary easing globally – both rate cuts and quantitative easing. This contrasted to the global monetary tightening that continued into early 2011.
• More Europe, not less. The European Central Bank’s bank funding operation and its threat to buy bonds in troubled countries combined with an ongoing theme from European leaders of “more Europe, not less” and more support for Greece reinforcing a determination to defend the euro, all helped head off the threat of a major financial crisis emanating out of Europe.
• The US comeback. While US growth has been subdued, the commencement of open ended quantitative easing by the Fed has kept growth going at the same time that signs of rebuilding gather with a housing recovery, surging oil and gas production, a manufacturing renaissance, and an ongoing tech boom.
• Cyclical bottom in the emerging world. Increasing signs that growth in the emerging world has bottomed has also added to global confidence. Chinese growth specifically appears to have bottomed out around 7.5%.
• Australia has also had a decent share of worries with a rapid slowing in mining investment at a time when non-mining sector activity remains weak. Growth for 2012 looks like coming in around 3.5% but this masks a slowdown to a 2-2.5% annualised pace. Inflation has been benign, despite carbon pricing, allowing the RBA to cut the cash rate back to its GFC low of 3%.
• An overwhelming investor theme in 2012 was the chase for yield in the face of zero interest rates in major advanced countries and falling rates elsewhere against a backdrop of investor caution. This benefited high yield assets. The following table shows returns for major asset classes.

Investment returns for major asset classes:

*Year to date to Nov. Source: Thomson Reuters, Morningstar, REIA, AMP Capital

Shares provided decent gains and setbacks were milder as a lot of the bad news had already been factored in, policy action was decisive and signs of improvement were evident in the US and emerging countries.

By region, European shares outperformed as investors sought their better value after several years of underperformance, followed by US shares helped by easy monetary conditions, Asian shares and emerging markets generally with Japan lagging not helped by a return to recession.

Australian shares performed well as the rate hikes which caused underperformance since late 2009 were reversed and the Chinese economy stabilised. Health care, telco, consumer staple and bank shares outperformed partly reflecting the defensive and yield bias of investors.

Global and Australian property securities had a very strong year as investors switched into high yield assets. Unlisted commercial property and infrastructure also performed well as investors sought their attractive yields. Bond returns remained solid as interest rates remained low or fell and central banks bought government bonds.

The $A rose slightly on US quantitative easing and central bank and safe haven buying reflecting its safe AAA rating, but has really been range bound for two years.

The strong returns from most assets resulted in solid returns for traditional balanced superannuation funds.

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