Financial markets focus: your questions answered

Q: How will the recent damage from floods affect the economy and investment markets?

A: Beyond the human suffering, there will also be three significant implications for the economy and investment markets: the obvious damage to wealth and associated repair and rebuilding costs; the impact on production or gross domestic product (GDP) growth; and the impact on inflation.

Getting a clear handle on the damage bill from the floods is difficult. However, given the extent of the damage to residential houses and public infrastructure such as roads, railways, bridges, electricity and water supply, we can expect the floods to knock around 1% of GDP (or $13 billion on an annualised basis) off the Australian economy in the December and March quarters – with rebuilding likely to be spread over several years.

Rebuilding should see 0.5% of this recouped by year end and a further modest boost to growth through 2012.

The Reserve Bank of Australia (RBA) is likely to look through the short-term boost to inflation and focus more on the short-term hit to growth, leaving rates on hold until around mid-year. However, once production rebounds and rebuilding kicks in, the RBA is likely to return to raising rates from around mid-year to head off an overheating in the economy.

While the floods have led to earnings downgrades, the impact on markets overall should be minor, in part offset by higher coal prices. Australian shares are cheap, having lagged global markets over the last year. My view is that the ASX 200 should head to around 5,500 by year end.

Q: Why are Australian shares underperforming, relative to global shares?

A: Australian shares have disappointingly underperformed traditional global shares over the last year returning just 1.6% in 2010 whereas global shares returned 10.4% in local currency terms. This underperformance can be attributed to monetary tightening, worries about a housing bubble, the strong Australian dollar (A$) and Chinese tightening.

Many of these concerns should be largely factored in and we see better returns this year, but some linger so it is too early to say the relative underperformance is over.

However, on a longer term basis, it is worth noting that despite Australian shares lacking the breadth and diversification of global shares, over the last 110 years Australian shares have had better real returns than most global share markets. See the chart below.

Real equity returns since 1900

Past performance is no indication of future returns.

Although, within this long run of outperformance there have been lengthy periods of relative underperformance – such as in the 1970s due to relatively poor economic management in Australia and the global tech boom of the 1990’s – the combination of higher dividends, better growth prospects, fewer structural constraints and franking credits for Australian-based investors suggest investors should maintain a bias towards Australian shares.

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What you need to know
The information in this article was provided by AMP Capital Investors (ABN 59 001 777 591, AFSL No 232497) and is current as at February 2011. 

While every care has been taken in the preparation of this document, AMP Capital Investors makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts.

This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. No reader should act on the basis of this article without obtaining specific professional advice. Further details are available from your planner or AMP Financial Planning Pty Limited, telephone 1300 157 173.