Shane Oliver outlines the key points likely to impact investor sentiment during the next 12 months.
2010 was something of a disappointment for many investors. While aftershocks from the global financial crisis will continue to cause volatility, 2011 is likely to be a much better year.
From a macro economic perspective, the following key themes are likely to be of relevance for investors.
Continuing solid global growth
Business condition indicators remain at levels consistent with solid growth ahead.
There remains plenty of pent up demand globally and, while fiscal conditions are tightening, monetary conditions remain very easy. In the US, strength in the corporate sector is driving a pick up in employment and capital spending.
Housing indicators appear to have found a floor and retail sales growth is surprising on the upside.
2011 is likely to see global growth of around 4.3 per cent, with growth in the emerging world of 6.5 per cent versus 2.5 per cent in advanced countries.
China is likely to grow by 9.5 per cent, which should be good for Australian resources stocks.
Essentially benign inflation
Excess capacity is likely to ensure inflation remains low in advanced countries.
Another year of easy global money
Very high unemployment suggests that interest rates in key advanced countries will stay near zero. This means that there will be plenty of liquidity sloshing around the global financial system looking for a home.
Solid profit growth
As economic growth continues, profit growth will likely remain solid.
Domestic growth
Australian economic growth is likely to be around 3.5 per cent over the year ahead but this will mask huge strength in the mining sector as a 50 per cent boost in mining investment adds 2 per cent to overall gross domestic product growth.
The overall growth backdrop will probably be enough to push unemployment down to 4.75 per cent by the end of 2011, but for homebuilders and manufacturers it may feel pretty tough.
Inflation is likely to be benign initially but to start later in the year as growth constraints start to impact.
While the Reserve Bank will leave rates on hold until the June quarter, we expect more hikes designed to contain inflation, which will ultimately take the cash rate to 5.5 per cent by the end of 2011.
Asset classes
Looking at the major asset classes for the year ahead, a number of themes will dominate.
After undergoing a decent correction in 2010, shares are well placed to put in strong gains in 2011.
Shares are cheap, the continuing economic recovery should underpin further gains in profits and the corporate sector is cashed up, which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends.
2011 is also the third year in the US presidential cycle, which usually sees above average share market gains.
The Australian ASX 200 index is expected to rise to around 5,500 by end 2011.
The Australian dollar is likely to remain solid on the back of high commodity prices and rise to US$1.10, but expect occasional sharp corrections as US growth strengthens.
Low starting point bond yields and a rising trend in yields as the global economic recovery continues is likely to result in poor returns from international government bonds. Corporate debt remains far more attractive.
Unlisted non-residential property is likely to see good returns on the back of yields of around 7 per cent and modest capital growth thanks to favourable space demand/supply fundamentals and investor demand.
In contrast, average house prices are likely to be flat due to poor affordability and the threat of more rate hikes.
What are the risks?
The main risks to keep an eye on are European sovereign debt, US house prices, Chinese tightening and any excessive tightening by the Reserve Bank of Australia, which could seriously threaten the Australian housing market.
Conclusion
The second year after a bear market ends often sees volatile trading and poor returns from shares. This has certainly been the case in 2010. However, the experience of past cycles points to the resumption of better returns in the third year and we expect this to play out in 2011.
Dr Shane Oliver is head of investment strategy and chief economist at AMP Capital Investors.
