What happens next ain’t pretty. The seeds of last year will yield a crop of unemployment possibly reaching over 12 per cent of the workforce and substantial numbers of business closures. Bad debts will mount as the false valuations of last year make way for the reality of cash-flow shortages. Property prices are unlikely to bottom out until reaching 50 per cent of their peak on average. In short, 2009 is going to see a shake-out of unstable businesses and individuals overleveraged or simply in the wrong place at the wrong time. Much middle class Irish wealth will be lost completely. Particularly hard-hit will be those who ignored the doctrine of diversification and chose to concentrate their investments in the same hotspot as their earnings. They include conveyance solicitors, mortgage brokers, builders, electricians, plumbers, engineers, architects, building suppliers, and the list goes on. These people are facing a sharp fall in income this year – half of what they earned last year if they’re lucky – and also face trying to finance investment property portfolios where rents are declining, vacancies are rising and opportunities for refinancing are effectively closed off despite the recapitalisation of banks.
WHERE’S THE HOPE?
Despite all of that, I start the year much more positively than 2008. This time last year, the storm clouds were gathering: investors had gone into lockdown as consumers, frightened by mounting evidence of instability in their banks, started saving rather than spending. There was no plan, no sign of global coordinated action. It felt like a runaway train beginning to gather speed. However, strange as it may seem in the gathering swirl of bad news, there’s plenty of reason for hope. While the economic revival plan outlined late in the day by the Irish Government contains some smart strategic thinking, the lift must come elsewhere in the global economy – from the big boys, especially the USA and China, without which everyone will struggle. It’s not written in stone, but a strong rally in financial markets and even in the US economy is still quite possible. What happens in the US will dictate the speed of any global recovery.
The build up of cash worldwide is truly staggering now, reaching well above proportions predating the outbreak of war in Europe in 1939. Meanwhile, interest rates have been brough down close to zero in the US, they're falling hard in China and set to decline further in Europe and the UK to historic lows. These many trillions of dollars, yen, pounds and euros will flood out to acquire sound assets that pay multiple returns from cash. That means high grade corporate bonds, large stocks like Intel that pay strong dividends and commercial properties with juicy tenants paying six to seven per cent on strong covenants while banks lend the finance at half that rate.
In sharp contrast to the 1930s, there has been a massive build up of the US monetary base (all the cash in circulation and bank reserves), which has nearly doubled over the past year. This is coming after nine months of economic weakness. It’s a trickle now, but this cash could eventually burst into the economy once the banking market unfreezes and consumer confidence returns. Rising unemployment is a slow indicator of economic performance. A better one is energy demand, which is up five per cent in the US. Cracks are appearing in the cash dam and retail sales were up 0.5 per cent in November.
One thing missing is the rallying point that inevitably arrives once the bottom of the cycle is hit and despondency and despair gives way to hope and recovery. That rallying point looks like Obama, who has assembled a formidable economic team with plans to inject close to a trillion dollars into the US economy over the next two years. Meanwhile, the Chinese are injecting half a trillion and the Europeans are putting in a little over a quarter of a trillion euros.
Financial markets have already factored in a multi-year recession, expecting corporate earnings to decline by 30 per cent. That’s why prices are at half their values compared to this time last year, with the ISEQ more greatly affected due to its property exposure. Despite continuing bad news – much of it pretty awful, from automakers to a $50 billion Wall Street fraud – markets have become a lot less volatile, reaching higher lows and higher highs since October’s bloodbath. Markets year-end were up 20 per cent from the lowest point, suggesting that something positive is stirring.
Over four trillion dollars has been built up by the hedge funds and other fund managers in the US alone who fled markets last year. Much of it now sits in ultra-low-yield US treasuries. When these aggressive juggernauts return to the game, the momentum created is likely to lead to the mother of rallies in underpriced stocks.
An upturn in the global economy could conceivably begin to occur in the second half of this year but it’s more likely to be 'saucer-shaped' recovery and not some kind of fast v-shaped bounce. Equity prices are unlikely to see their past highs for several years to come. The real issue facing the world as it emerges from this recession is inflation. Regular readers will be familiar with the arguments supporting a long-term problem with oil-led inflation but what will first ignite it this time around is the devaluation of currency, especially the dollar due to the massive increase in money creation as Governments borrow to the hilt to finance spending booms.
Ireland’s recovery will be slower than economies less exposed to a property bubble burst. This may mean we get caught in a vicious cycle of stagnant or declining economic activity while, globally, prices begin to race skywards again for energy and food commodities. If European recovery advances faster than ours does – especially in Germany, France and Italy – we could also face rising interest rates to boot.
1. Get debt-light. Shed as much as you can by selling liquid assets and property if your occupation is heavily exposed to a multi-year recession. You don’t want to try to service debt from declining earnings or debt, which rises in real terms if Ireland hits a deflationary stretch.
2. Invest some money in gold, ideally up to 10 per cent of your investment assets. If we hit inflation on a global upturn, gold will rise, especially as the dollar tanks and oil prices surge. If the interest rate cuts and massive increase in government spending fails, we’ll hit a depression, another good reason to hold some gold. You can acquire Perth Mint Certs from Gold.ie or buy shares in an Exchange Traded Fund like Lyxor Gold Bullion Securities.
3. European interest rates are likely to fall even further over the next month or two. Be prepared to switch into historically low mortgage rates even in a dysfunctional mortgage market as Irish lenders recover from last year’s turmoil and normal competition resumes.
4. Lock in your cash deposits at the best 12-month rates you can get but maintain access. Avoid putting away capital for five to 10 years. Future capital guarantees won’t be worth a toss if inflation hits high single or double digits.
5. Put a few quid now into Index-Linked European Government bonds. In the retail fund market, Standard Life has an offering.
6. Energy investments have been hit by falling oil prices on the one hand and a tougher borrowing climate for capital-intensive alternative energy companies on the other. This could come around quickly on an upturn, so if you fancy a punt look to funds and stocks that give you exposure to global energy players.
7. Commercial property yields, especially in stable markets like Germany, are looking even more attractive as interest rates fall. Keep an eye out for good syndicate funds that will inevitably re-emerge this year if confidence returns.
8. There are many strong Eurozone companies with lots of cash on their balance sheets and good records in paying dividends, including utilities and even financials. You can invest in these through specialist funds like Canada Life’s Dividend Bond Fund or JP Morgan’s European Strategic Dividend Fund.
9. If you’re thinking of changing careers, consider what sectors are more recession-proof than others. It doesn’t have to be the public sector, although it does help! Look where the Government is spending money right now – training, R&D, alternative energy and infrastructure. Whoever has these contracts is pretty secure.
10. If you’re smashed for cash temporarily, there are things you can do. Look to selling assets you don’t
really need on EBay. Check out opportunities to get a second job. Don’t be slow about moving overseas to pursue your career. Commodity-rich economies like Canada and Australia are probably the best bets. Better to be elsewhere adding to your CV than unemployed at home. Remember, you can always come back for the next cycle.
