Day after day, week after week, the US and Australian markets remain remarkably strong, often notching new highs, yet recent earnings results have been somewhat less than expected, both economies are slowing perhaps more than expected, and there are deep seated structural economic problems, particularly in the US, and political uncertainties that one day must come to the fore.

At the end of last year I saw a survey of Wall Street opinion in which all economists, commentators and pundits predicted that the US stock market would strengthen throughout 2007. That made me particularly nervous! For when a group of economists and pundits all finally agree on something, then you’d better expect that it won’t happen!

The uncertainties of the oil market continue with further significant spikes in the oil price possible, as geo-political tensions unfold in the Middle East. In the US, the housing bubble has clearly burst. Consumer spending is slowing significantly, as is overall growth. But the key structural issue is the US current account deficit, now threatening US$1 trillion, or 7% - 8% of GDP.

In any normal middle level developing country, even allowing for heavy reliance on foreign investment for development purposes, a current account deficit problem of this magnitude would suggest a crisis in the offing. Yet, because the balance of payments surplus countries, heavily concentrated in Asia, are happy to hold US dollars as an international reserve, the US is able to get away with it. For now, at least!

In Australia, our growth is clearly slowing much more than the Government and its official advisors have yet been prepared to admit. Despite the mining boom, the export sector hasn’t yet contributed to growth as predicted, to off-set the collapse of the housing sector and the resulting slow down in consumer spending.

Our stock market remains strong, principally because of the massive flows of superannuation monies, with funds under management now over A$1 trillion. Many now expect the inevitability of compulsory superannuation being increased from 9% to at least 15%, if we are to get to a sustainable situation where superannuation, overall, can effectively meet the requirements of our ageing population.

 Overlay all this with considerable political uncertainty in both the US and Australia. Bush is a lame duck President, intent on “winning the unwinnable war” and totally distracted from domestic economic issues, as well as the mounting geo-political tensions in the Middle East, as Iran will soon have its nuclear bomb. Moreover, the race for the Presidency in 2008 is now well underway, and getting increasingly less certain each day as new entrants appear and more established candidates falter.

In Australia, Howard now has a real fight on his hands in what promises to be one of his toughest election contests yet, although for the Government to be defeated Rudd needs a uniform swing of nearly 5%, and some 16 seats, a big ask in most political circumstances.
Although there is an eerie sense presently dominating financial markets that 2007 will be pretty much like 2006, more of the same, the elements I have mentioned, and others, could produce particularly volatile financial markets as the year unfolds, where basic asset choices between cash and fixed interest on the one hand and domestic and foreign equities on the other may need to be reassessed.