December Market Commentary

December Market Commentary

Monthly Economic & Investment Market Commentary

December 2012

As well as a quick review of the major events of 2012, we will focus on outlining our views for the New Year, and discussing the likely issues that will influence the performance of investment markets and your portfolio. We will this month delve again into the absurdities that are becoming all too common in the United States, and then in coming months will spend some time considering the progress in Europe towards resolving their problems and the path towards greater integration. The new leadership in China will formally take office later in 2013, and their economic performance will of course be of enormous significance to the rest of the world, and nowhere more so than here in Australia.

However, first we look at the conclusions from a recent working paper published by the IMF, which has concluded that “stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis.”1 That is to say that the contractionary impact of raising taxes and cutting government spending is greater than had been previously thought, and this is especially so when an economy is very weak, such as in the aftermath of a financial crisis.

On a few occasions in these commentaries over the last few years we have made reference to a grand social experiment that was being played out before us. The components of GDP are private consumption, investment, government spending and the net value of exports over imports. Increasing taxes decreases the amount that households have available for consumption, and will also likely mean that investment is at least delayed until demand picks up. If at the same time the government is reducing its own spending, then the positive contribution to GDP comes down to a country’s ability to export. However, this can be a real problem if all of your export partners are facing the same scenario and attempting to implement the same policy response.

That is the one side of the social experiment, imposing austerity policy measures on a weak economy and there are now recent examples that the most likely outcome is recession. What the IMF has said is that the impact of ‘fiscal multipliers’ is much greater, which is the actual impact of a reduction in government spending on the overall economy. The Washington Post outlines the impact:

“If fiscal multipliers are small, countries can cut spending faster or raise more in taxes without much short-term damage. If they are large, then the process can become self-defeating, at least in the short run, with each dollar of government spending cuts, for example, costing the economy more than a dollar in lost output and thus actually increasing debt-to-GDP ratios.

That is what has been happening with a vengeance in Greece, where fund forecasters, as part of the country’s first bailout program in 2010, predicted that the nation could cut deeply into government spending and pretty quickly bounce back to economic growth and rising employment.

Two years later, the Greek economy is still shrinking and unemployment is at 25 percent.”2

Households in most developed economies have for the last few years been trying to pay down debt and increase their savings, seeking to repair their balance sheet following the debt fuelled consumption that took place in the years before the financial crisis. Some have lost their jobs and some have lost their homes, and the impact of all of this is less demand for goods and services in the economy. The alternative approach in the social experiment is for support, both monetary and fiscal, for a weak economy. In other words, a counter-cyclical policy approach which supports a troubled economy and then gradually tightens against excesses in more buoyant economies.

Of course, the problem with this latter approach is that it relies on governments to identify and efficiently implement these policies, and of late there has been some cause for cynicism about that ability.


Small business owners in the United States have until recently listed poor sales as their single most important issue, though in the latest survey3 taxes and government red tape are also at the top of the list of concerns. The commentary on the survey included: “Inventory demand fell, job creation plans weakened, both from levels that were already in the hole. Capital spending remains weak. Seventy percent of the owners characterize the current period as a bad time to expand; one in four of them cite political uncertainty as the top reason.”

The country’s leadership has just reached a piecemeal agreement on the fiscal cliff, but has again shown no capacity to reach any broad agreement on long term measures to address their problems. In fact, much of the early weeks of January 2013 has been spent debating the merits of minting a US$1 trillion coin to avoid the debt ceiling standoff that is just weeks away. First, let us provide some background to the latest calamity awaiting the US economy.

Prior to 1917, Congress had to approve each new bond issue from the US Treasury, though with the advent of World War I this was seen as inefficient and hence an overall level of allowed debt issuance was adopted, which we now know as the debt ceiling. Whilst there have been historical occasions when raising the debt ceiling has been used to provide political leverage, it has by and large been an administrative formality. It is also worth making clear that the debt ceiling is giving approval for the US to pay the bills that are already due, it has nothing to do with future spending. The time of this process being just a formality is very much in the past. The current arrangement is for a game of brinksmanship between Republican leadership in the House avowing to hold the US economy hostage to extract concessions from President Obama, who in turn says he will not negotiate on this issue.

So, this brings us to the debate over a proposal that the US Treasury could use laws which allow it to mint commemorative platinum coins to avoid the debt ceiling issue entirely. In this instance there would be just one coin, created with a value of say $US1 trillion, which the Treasury would then transport, very carefully one assumes, to the US Federal Reserve. The Fed would in turn credit Treasury’s account and this would allow bond issuance to continue. This is assuredly a ridiculous proposal, but then the alternative could be the US defaulting on their debt for no other reason than partisan politics. The full consequences of a default are difficult to fathom, but have been estimated as a “sudden 39% decrease in government spending, resulting in severe recession, plunging global markets, rating agency downgrades, widespread uncertainty and public unrest. Moreover, the damage to the credit rating of the U.S. would lead to far higher interest payments for years to come.”4

Treasury has said they don’t intend to issue such a coin, and the Federal Reserve has said they would not accept it5, yet the time to reach an agreement draws closer each day. Meanwhile, the piecemeal agreement raised taxes on all American wage earners via the expiration of a temporary cut in payroll taxes, and large automatic spending cuts were only delayed by two months.

We again expect that there will be a last minute compromise on this issue, though it is difficult to avoid thinking about what the Americans will come up with as the next self-imposed opportunity to sabotage their economy. Unfortunately, we will likely not have long to wait before we find out.


We will leave you for this month with the following diagrams that show whilst the US continues to dominate the news media and global share market indices, when it comes to GDP there is a very different story to be told.

We continue to see good value in these countries, which represent 50% of global economic output but just 13% of share market capitalisation. Economic growth will certainly be greater in these regions than in the United States and Europe and at the moment prices represent good value to access that growth.



The table below shows our long term (10 year) expected returns from four asset classes; Australian shares (represented by All Ordinaries index), international shares (S&P 500), Emerging Markets (represented by the FTSE Emerging Markets Index) and listed property (ASX 200 Property). The four valuation ranges, represented by the different colours, are determined by comparing the return we forecast, to a risk free rate of return (Term Deposit rate).


1. O Blanchard & D Leigh, Growth Forecast Errors and Fiscal Multipliers. IMF Working Paper. Jan-13.
2. Howard Schneider, An amazing mea culpa from the IMF’s chief economist on austerity. Washington Post. 3-Jan-13.
3. W. Dunkelberg, Small Business Economic Trends, NFIB. Jan-13.
4. Comstock Partners, The Disastrous Consequences Of Not Raising The Debt Limit. 10-Jan-13.
5. Ezra Klein, Treasury: We won’t mint a platinum coin to sidestep the debt ceiling. Washington Post. 12-Jan-13.

 DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of CHPW Financial Pty Ltd AFSL 280201) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.

About Reuben Zelwer


Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.