Feature Stories | Dec 12 2007
By Greg Peel
“The benign fundamentals of 2003-2007 – buoyant global growth, soaring profitability, and falling credit risk premiums – have been replaced by credit stress, pressures on the capital position of the financial system, a maturing US and global business cycle, as well as soaring energy and food prices. Economic, financial, and commodity price developments now threaten the global expansion – or at least significant parts of it – in ways not seen since the bursting of the tech bubble and the US recession of 2001-2002.”
No one could have put it much better than the global asset allocation analysts at UBS.
2007 has been a remarkable year. One need look no further than the extraordinary level of volatility in global stock markets to realise that fear and loathing have been a significant theme. Yet it was such a sunny start back in January – emerging market economies were growing at a rapid pace, Japan could see some light at the end of its long tunnel of deflation despair, Europe was dragging itself out of its own benign doldrums and the economies of countries such as Australia, New Zealand, and Canada were riding along on the crest of a seemingly endless commodity wave. The US economy was easing off a little, due to an overdue pullback in a bubbling housing market, but the stock market was strong and any housing correction was seen as fairly minor in the grand scheme of things.
The end of 2006 had marked the second anniversary of the devastating Asian tsunami of 2004. If the millions of people living on the Indian Ocean coastline had learnt one thing that fateful year, it was that if the water suddenly starts rushing away from the shore it is time to turn and start running as fast as possible into the hills. For this is what happens when a gigantic wave is heading towards you, sucking all the volume it can from the coastal shallows before delivering back again with almighty interest.
Unfortunately this lesson was lost on world financial markets – analogously – when in February the Chinese stock market caused a fright around the world and fell 9% in a day. The jubilant mood of January drained away from the market quite suddenly as the world realised it was holding an awful lot of risk. Given the story of global strength was founded almost entirely on the footing of the Chinese economic miracle, a sharp correction in China was enough for jittery investors to reassess their very naked exposures. It was through a short, sharp and panicky reaction to such exposures that the world learnt of what was for many a previously unappreciated asset.
This was something called a “subprime” mortgage.
The Chinese stock market quickly recovered and the world breathed a sigh of relief. But as the water started rolling back to the shore little did anyone much realise that the subprime problem had not gone away, it had simply continued festering far away from the public spotlight in the dark recesses of the over-the-counter market. Slowly the waves started to build until finally, towards the end of July, the big one hit. Bear Stearns had announced it could not find any buyers for around US$6 billion of mortgage-backed securities known as collateralised debt obligations, held in two of the investment bank’s hedge funds. On that basis, the hedge funds were now worthless.
Even as the first rather sizeable waves had hit the shore sceptical commentators were dismissing their significance. Only when the big one rolled in – dubbed the “global credit crunch” – did even the sceptics started handing out life jackets. But by then it was too late.
As 2007 draws to a close the world is facing a Christmas celebration with an unnerving concern that it may be about to fall into a crippling recession. FNArena has assembled predictions as to what the new year may bring from a raft of financial analysts. They include the global strategy teams from UBS, JP Morgan, Merrill Lynch, Goldman Sachs, Citigroup, Schroders, Danske Bank and Unicredit.
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Considering the second half of 2006 was marked with an extreme level of uncertainty and polarised opinions, it’s somewhat surprising to realise that a significant sample set of global strategists has come up with what is sufficiently a consensus view on what will transpire in 2008. That is not to say caveats haven’t been attached by one and all, but there is virtually no polarisation of opinions in this case. To sum things up, this is what our sample set largely agrees on:
– The US economy will slow dramatically but it will not recede.
– The US Federal Reserve will continue to cut the cash rate, such that it falls to between 4% and 3.5% by the middle of the year.
– The Asian economies will waver but will be revealed to be largely decoupled from the US.
– The European economy will appear decoupled for a while before it, too, will suffer a dramatic slowdown.
– The Japanese economy will improve, but not markedly.
– The US housing market will continue to deteriorate through 2008.
– The global financial system will remain in a level of turmoil until some time around mid-year.
– The US dollar will continue to weaken over the same period.
– The global economy will revert to trend growth.
– The sovereign wealth of Asia and the Middle East will be the new player in town.
On these factors our analysts are largely in agreement. Of course, one should be rather concerned when economists agree on anything, for it usually means the opposite is about to happen. But for now, we can take solace in the fact that opinions across the globe have not found our pundits in a bar-room brawl. For if enough market participants are prepared to accept the views of the experts, there is also a good chance they will prove self-fulfilling.
The last time a significant financial crisis hit world markets was in 1998 when one lone hedge fund – the now famous LTCM – became insolvent. The ramifications of the positions held by the fund for global markets in everything from sovereign debt to gold were such that the US Fed, in alliance with the Bank of England, other global central banks, and every major investment bank in the world, conspired to rescue LTCM before it went under owing around US$6 billion. It was one of the darkest hours in the history of capitalism.
On December 10, 2007, one of Switzerland’s, and the world’s, largest banks – UBS -announced it would write down a further US$11 billion in credit market losses and at the same time receive a capital injection for roughly the same amount. The world barely blinked, and indeed global stock markets closed higher on the day.
UBS’ write-down took total global investment bank write-downs – those announced to date – to well over US$60 billion. It is believed that there is now some US$500 billion of mostly distressed assets sitting on bank balance sheets around the world that said banks would rather not have had to take on board. It kind of puts the irritating flea that was LTCM into perspective.
The rescue of LTCM in ’98 was swift and decisive. What it had clearly illustrated was that the entire world hung on the balance of the strength or otherwise of the most dominant force the world had ever known – the US economy. By averting danger, the way was opened up for the world to begin pouring its investment riches into a new American phenomenon – the internet. In two short years the world experienced one of the most remarkable bubbles in the history of stock markets – and there have been many. This was a paradigm shift in the global economy. This was the future. This was a time when the age-old reliable concept of the share price to earnings ratio of a listed company went straight out the window. This lasted about five minutes.
To understand what happened in 2007 is to understand what happened in 2002. The world went into recession that year because the US stock market collapsed when the tech bubble burst, and also because 9/11 (2001) brought a new threat to global stability. What then Fed chairman Alan Greenspan knew was the fate of the whole financial world rested on the performance of the US economy. Thus by 2004 he had cut the US cash rate to 1%. The cash rate of the world’s second largest economy – Japan’s – had already fallen to zero after years of deflation. Together, the two central banks ushered in the rise of the subprime mortgage and the collateralised debt obligation in particular, and rampant undervaluation of global risk in general. It was the golden age of excess liquidity.
It is also important to remember that prior to 1998 the Asian “tiger” economies had been forming their own bubble, driven by over-inflated currencies and dangerous current account deficits. When that bubble burst in 1997, Asia – which for centuries had been built on a culture of not “losing face” – swore it would never let it happen again. Once the pieces were picked up, China decided it was time to emerge into the industrial world. No one – Greenspan included – ever predicted what would happen next.
China has continued to confound the traditionalists – those who had spent a lifetime more or less correctly spotting peaks and troughs in perennial economic cycles. Few of today’s global strategists were even alive when a similar industrial emergence crept up on the world after World War II – Japan’s. But as we enter 2008, the China factor has now been accepted and more or less understood. And it is upon this basis that today’s global strategists have been able to come to a consensus on what is likely to happen in the new year.
The King is dead – long live the King.
Well maybe that’s a bit strong. Let’s just say that we now live in a world of greater global economic democracy of sorts, rather than the previous state of American autocracy. Not that it was particularly America’s fault it was autocratic – America has simply been the dominant team in the league – the one that can afford to buy all the best players. But there is a snippet of irony in the fact that it was America which saw the opportunity to “globalise” the world for profit, and that is very much a reason why it is no longer so autocratic. It is also globalisation that will help save the US economy. As will the internet – which is another source of irony.
The US Economy
On December 10, the US National Association of Realtors declared that the US housing crisis, which began in 2006 as a pullback and accelerated into 2007 as a slump, thus setting off the default of subprime mortgages, appeared to be bottoming out and that 2008 should see a modest recovery. While the NAR is no doubt a revered organisation, if you want to know which way housing values are going it’s best not to ask a real estate agent. It would be akin to asking a used car salesman whether that knocking sound coming from the engine of the car you’re about to buy is anything to be worried about.
The truth is that all of our global strategists believe the US housing crisis is currently in an acceleration phase, and that 2008 will see the continuation of falling house prices. Only in 2009 can we expect there to be some semblance of a recovery. This is despite the Bush administration’s subprime rescue plan, which in reality does not solve the problem but only allows some breathing space for a chosen few.
The risk to the US is that housing activity continues to drag down economic growth and undermines consumer confidence. With equity value lost in their homes, the average US consumer (and actual defaulting Americans still represent only a small proportion) will decide it is better to save money than to spend it frivolously on “things”. Unfortunately for the US, the sale of ‘things” represents about 70% of GDP. It is also clear this is what is already happening.
If retail sales slow, job creation slows. US job numbers have to date proven relatively resilient but the trend in growth is undeniably down. And it is expected that post-Christmas this trend will weaken further. If job losses accelerate, a spiral begins.
In the US business world we still have a situation where credit markets for all but the financially secure few are still largely frozen. The credit markets are still “de-leveraging”, meaning risk is being shunned and balance sheets are being returned to a safer state. Credit is the fuel of business expansion, and while there remains doubt and suspicion amongst lenders and borrowers the tap will remain mostly turned off. The process of disclosure has now begun in earnest, having been little more than a farcical, stage-managed parade of wounded soldiers while the body bags were being spirited out the back door, at least up until November. Apart from the fact that new accounting rules came into effect in the US in November – rules that force the write-down of CDOs and other distressed assets – global financial institutions have begun to realise it is more beneficial to stand before the crowd in full, naked glory. Only then is someone likely to offer you some trousers.
Two global banking superpowers leap to mind in this sense – Citigroup and UBS.
But the process is far from over yet, and indeed it is not necessarily the fault of the financial institutions involved that it is not. (It is their fault they are in the situation in the first place, but this report is not going to go down that path). Many of the mortgage-backed assets at the root of the credit crunch problem can still roll to maturity and provide at least some return, without having to be fire-sold. The problem is that no one wants to actually take them off the owners’ hands, suggesting they aren’t worth anything at present. Of course they are worth something to someone, particularly risk-loving bargain hunters who thrive on buying and selling distressed assets, but through a combination of Federal Reserve and US government intervention – rate cuts, super SIVS and mortgage reset freezes – a bargain hunter cannot be assured of a pure and fair playing field.
Our strategists agree that the US economy cannot consider any form of recovery until financial uncertainty has been worked out of the system. Consensus suggests this will take six months yet, and will only be made possible due to aggressive rate cutting from the Fed in order to reduce the cost of credit and restore confidence. One important factor will be the mandatory release of the financial sector’s audited 2007 full year accounts in the first quarter of 2008. This should, in theory, provide the nadir for the skeletons in the cupboard. Only when the market is confident those skeletons have been fully paraded can the market be then confident that the worst is past. The market has tried many times in late 2007 to declare a bottom in the US financial sector of the stock market, only to be thwarted each time. It took a while for the world to realise there was another wave behind the big one.
(This was actually folly to begin with – the one big wave had never really passed yet).
A combination of lost consumer confidence and ongoing financial uncertainty are the factors which will combine to bring the US economy to pretty much a grinding halt at the beginning of 2008. To call it a grinding halt is to split the difference between those expecting a slip into recession and those expecting a slowdown to a mere 1-2% of growth. The consensus among our strategists is that the US economy will not actually recede, but that if it does negative territory will only be minor and last no more than two quarters (which is, nevertheless, required to define a “recession”). The reason consensus is not one of doom and gloom harks back to our “globalisation” thesis.
The US dollar had already been weakening as we entered 2007 due to the sheer extent of the US current account deficit – a deficit that reflected large trade imbalances with the globally large economies of Japan and Germany, and also a rapidly expanding imbalance with China. When the credit crunch hit, the US dollar’s slide only accelerated. When the Fed started cutting rates, it fell further. The Fed has now cut by 100 basis points – from 5.25% to 4.25% – since August. The consensus among our strategists is that given the problems ahead for both the US consumer and financial services, the Fed will continue to cut by a further 25-75 points. This will put the target funds rate at between 4% and 3.5% by mid-2008.
The strategists have not paid much heed to the fact the Fed has seemed to pussy-foot around in its easing policy. When it cut by 25 points in November, the suggestion was that would be enough. The market then started to think another 50 points was on the cards in December, but the Fed delivered only 25, along with another overly optimistic statement. Wiser heads have suggested however, right from the outset, that the depth and breadth of the credit crunch will force a significant easing phase, even if it is only step by step.
One reason the Fed had pussy-footed is because of its continuous warnings on inflation. There is no doubting the prices of food and energy have skyrocketed and as such add to the weight of burden on the American consumer. The Fed is loathe to stimulate the economy through monetary policy easing, only to allow commodity prices to continue to run higher and inflation to bite.
Despite the Fed’s fears, inflation readings have remained surprisingly benign. To the strategists, this is a reason why inflation is not a major concern and why the Fed can go on happily cutting rates. For one thing, the US dollar’s ongoing weakness will likely be more of a stabilising factor than, as Citigroup puts it, an “inflationary spur”. The dollar is falling because the US economy is slowing.
The strategists believe the US dollar will continue to fall over the next six months, eventually reaching a level of between US$1.50 and US$1.55 to the euro. Because this is a reflection of not just rate cutting but of economic weakness in the US, energy prices will begin to fall. Housing price weakness has already been, and will continue to be, a deflationary force. Citi finds it bemusing that the Fed should still be focussed on inflation. As the housing bubble was forming in the US, rising inflation was the Fed’s biggest enemy. Hence the seventeen rate increases from 2004 to 2006. Now that the bubble has burst and the market is weakening, why is the Fed not expecting inflation to ease?
The belief among strategists that inflation will cease to be a threat only strengthens the weight of argument that the Fed will keep cutting. The US dollar will thus keep falling. But while the Fed cuts to overcome the recessionary forces at work in the domestic economy, the falling dollar will actually be the US economy’s saviour. This is the safety net.
The US has long embarked on a process of globalisation. Much to the chagrin of anyone over about thirty, every city boulevard and every main street or high street in every town in the world now looks tediously homogenous. There one can see only the same fast food, coffee and clothing outlets, the same glowing logos, the same “have a nice day” service. America has taken its consumer culture to the world.
At the same time America has led the charge in anything to do with computers – hardware, software, internet services and must-have devices such as iPods and Blackberries. It also dominates the pharmaceutical landscape. It has long been the primary source of entertainment, from music to movies and television. In short, America still dominates the world as a designer and seller of “things” that are sought after in all corners of the globe. America is a major exporter, and as such when the US dollar falls, and the rest of the world can better afford American “things”, the coffers of US exporting companies grow.
Nowhere was this more evident than in US third quarter corporate earnings (and will be more so in the fourth). Domestic retail earnings were shaky, housing related earnings were horrendous, and financial earnings were ugly. But any company with 50% or more of its earnings derived from beyond US shores came out smelling like roses. As the US dollar continues to fall, these earnings will continue to grow. And there is a whole new market out there – in China, in India, and in other emerging markets. Many large US companies now boast a significant proportion of offshore earnings. As UBS puts it: “The US is a somewhat defensive market, where its large cap geographic diversification is underappreciated”.
The flipside of the globalisation theme has been the outsourcing of the manufacturing sector to China and others, and the outsourcing of services to India and others. This outsourcing has helped drive the runaway economies of those countries. But the real money – the real profits – are still collected back in the US. Returning to that irony regarding the internet – it has been the growth of instantaneous global communication that has allowed the “globalised” world to thrive.
The tech boom and bust occurred because the world wasn’t quite ready, and because bubbles will often form more quickly in a sector that most don’t understand. In 2001 the US dollar was much higher, interest rates were higher, and the US domestic economy was by far the world’s most dominant. Price earnings ratios of US listed companies were very high, and in the case of internet companies they were indeed meaninglessly infinite. The scene was well and truly set for not only a bursting of the bubble, but the recession that was to follow (even without taking 9/11 into consideration). To use a phrase unpopular among economists, things are different now.
While hedge funds may have suffered because they leveraged themselves to the hilt, and banks are struggling after bringing distressed assets back onto their balance sheets, US corporate balance sheets are for the most part very healthy. Indeed the US corporate sector is, on aggregate, in surplus. This means that in a period of tight credit conditions US corporations are actually suppliers of liquidity, not demanders. Had US corporations been themselves highly geared going into the credit crunch, it would be a very different story.
Moreover, before the credit crunch hit, US PE ratios were still historically comfortable. This was one reason why the bulls expected the golden days to just keep rolling on – there was still plenty of upside. Now that much of the US stock market has been heavily discounted, PE ratios are actually historically low. This is in complete contrast to the position leading into the tech wreck and the subsequent recession.
It must also be remembered that the US economy was already enduring a period of cyclical economic slowing as it entered 2007. The housing market had begun to slide in 2006. Yet as we are about to enter 2008, it is notable that US unemployment is still very low, and so far jobs growth is proving resilient, disposable income has been growing strongly and productivity has also made healthy increases. After a year of weakness, only now are there any concerns about a possible recession. And despite the still-sliding housing market, there is little sign any of this weakness has materially spilled over into other areas of the economy.
Put this all together and you have the reasons why our strategists don’t see a recession in the US, or at least don’t see any deep or protracted one.
The European Economy
The credit crunch could not have come at a worse time for Europe and the UK. European economies were just beginning to find their feet after years of doldrums as we entered 2007. The euro was appreciating slowly but calmly against the US dollar, and inflation was threatening but not yet dire. Unfortunately for Europe, however, the credit crunch has kicked it in the teeth.
Perhaps the greatest example of Europe’s pain was the collapse of UK bank Northern Rock, and the extraordinary steps the Bank of England was forced to take to save the deposits of millions of average Brits – not just Northern Rock customers, but all British depositors. Not since Victorian times had there been so spectacular and violent a run on a British bank. But while Britain and Europe were victims of a global credit crunch that began in Small Town America, they had also previously been suckered in by the riches on offer from US-designed credit derivatives such as subprime CDOs – more so than anyone else in the world outside the US.
Entering 2007 Europe’s economy was growing and the US economy was contracting. Hence both the euro and the pound have appreciated substantially against the US dollar. At the same time, commodity inflation remained a threat. Hence while the US Fed has since cut rates by 100 basis points, the Bank of England has only just cut by 25 points and the European Central Bank has not yet budged, despite massive injections of liquidity into the banking system.
Our strategists believe that there is a level of decoupling of the European economy from the US economy. This means that Europe could readily stand on its own two feet if the US were failing. Indeed – that was exactly what was happening twelve months ago. But our strategists also believe the US dollar will continue to fall. The offsetting strength in the euro and pound will then scupper the European export industry.
Europe is now beginning to see the same early stages of housing market weakness and falling consumer confidence that the US has been experiencing. While the US economy’s sharp slowing from here will not drag Europe down directly, the currency will. Only when inflation begins to turn (and oil prices, in particular, fall) will European central banks be able to start cutting their rates, or cutting more aggressively. According to consensus this will occur in about six months. And that’s when the US dollar will stabilise – when rate cuts hit the euro and pound.
The real danger for Europe is that it is more vulnerable to an economic slowdown. Indeed, some of our strategists believe that in six months time it will be Europe staring down the barrel of economic recession, just as the US is recovering.
The Japanese Economy
With all the talk of surging China and other emerging market economies, it’s easy to forget that the Japanese economy is still the world’s second largest, and a long way above either Germany or China (which is now challenging for third). Like Europe, Japan entered 2007 feeling upbeat – it looked like a decade or more of deflation since the Japanese bubble burst in spectacular fashion might finally be behind the global superpower. Japanese multinational large caps have always performed well (just this year Toyota took over General Motors as the largest seller of vehicles in the US, for example) but domestically the economy has proven no less than a struggle.
It was this deflation that led to zero interest rates in Japan, and the birth of the yen carry trade. In a lot of ways the yen carry trade is as much to blame for the world’s fateful risk appetite growth in the twenty-first century as US monetary policy easing after 2001, but there has been little the Bank of Japan could do about it. But interest rates had risen to 0.5%, and analysts were beginning to call the re-emergence of Japan, just as the credit crunch hit.
Japan has not been hit as hard as the US or Europe by the credit crunch, but it hasn’t helped much. The pervading view now is that the Japanese stock market may be set to go for a run given dividends now exceed bond yields, and whenever that happens it is positive for Japanese stocks – particularly banks. Our strategists largely agree that Japan will not suffer, but fundamentals remain shaky and any economic growth spurt will be modest.
One element to consider, however, is that carry trading will ease off due to a global rethink in risk appetite. This will relieve pressure on the yen, and may yet allow Japan to creep up its interest rate and attract more domestic investment, albeit slowly.
Emerging Economies
Now we get to the nitty-gritty.
The great fear is that if the US economy goes into recession, or at least slows markedly, the great Asian economic miracle will be over. This would have global ramifications as China, India et al have been the great consumers of global commodities, fuelling the economies of commodity producers such as Australia, and the great manufacturer of cheap goods to the world, keeping inflation in check. The US is a significant consumer of Chinese goods, including those goods (such as computers, for example) that the US outsources for manufacture. If the US stops buying, is it game over for everyone?
Let’s just return to the Asian crisis of 1997. In that year the “tiger” economic bubbles burst as Asian currencies came crashing down. It was a major set-back to Asian emergence. But like any bubble, the fledgling and inexperienced Asian economies had run too hard, too fast. Currencies were allowed to overvalue precipitously as current account deficits widened and widened. The tigers had no fire-power to support their currencies, and soon the market turned.
If anyone learnt a lesson from the Asian Crisis it was China, which at the time was still very much entrenched in communism and not really one of the tigers. It had, however, begun its first real economic growth but the road proved very volatile. China learned that the best thing to do was to peg its currency to the US dollar. It also boasted the world’s largest labour force, one for which even a dollar a day seemed the height of affluence only a few years ago. China opened its arms to Western manufacture outsourcing, and the rest is history.
A decade later we are now in a situation where, in terms of current account surplus, China is one of the richest nations on earth. Pegging to the dollar has only intensified global imbalances, but it has allowed the Chinese economy to grow at the pace it has. Perhaps it should have happened much earlier, but as the US dollar continues to weaken the Chinese renminbi will appreciate at a steady pace. Chinese financial markets are increasingly being reformed and modernised, and investment money is flowing in. And China has a vast pool of foreign reserves with which it can protect its currency and its financial system – the diametric opposite of Asia in 1997.
The most important factor, as we approach 2008, is that the Chinese domestic economy is now growing at a galloping pace. Local business investment and infrastructure spending are soaring along. The emerging middle class contains a population that dwarfs that of all of Europe. The Chinese are ready to spend, and spend big. While China continues to absorb the world’s resources at an astounding pace, the proportion of production actually now making its way to the US as exports has fallen substantially.
China is decoupling from the US. Not yet completely, but significantly. That is not to say that a slowdown or recession in the US won’t have an impact. But China and the rest of Asia (ex-Japan) now has, as Schroders puts it, “a momentum of its own which is positive”.
JP Morgan forecasts 2008 will be the fifth year of steady economic growth in Asia. “The region’s structural story continues to improve with reflation on track and accelerating public and private sector fixed investment”. Citigroup notes that in 2007, for the first time, emerging economies will make a bigger contribution to global GDP growth, based on nominal GDP weights, than industrial countries. The consensus among our strategists is that the Asian story will not be defeated by US economic weakness. There will be a slight stumble, but no fall.
The Global Economy
Put it all together and what have you got?
Through 2006 and the first half or 2007, global GDP was growing at a rate of around 5%. Our strategists agree that in 2008 the global economy will weaken, but it is in for a very soft landing. Expectations vary on just how “soft” this might be, from a forecast of perhaps only 0.25-0.50% weakening, to a more pronounced “reversion to trend” of around 3.8%. Either way, the world is not going to hell in a handcart, as far as our strategists are concerned.
It might, however, be a more austere world.
The Australian Economy
Not all of our auspicious strategists have deigned to pass comment on the little faraway economy that is Australia’s, but JP Morgan’s views sum up those that FNArena has encountered recently.
Australia has been left largely unscathed by the credit crisis, although not totally unaffected. Given consensus views that damage to the US economy will be limited, and that the Chinese economy will continue to grow strongly, JP Morgan sees an ongoing positive environment for Australia. Corporate earnings growth hit 18% in the year ended June 2007, and was 20% in 2006. Growth will continue at above trend levels in 2008, but not quite as markedly. A strong Aussie dollar will be a dampener, and growth levels should only reach the low teens.
There will be an undeniable effect from some weakening in commodity prices, from labour cost pressures and from increasing interest expense. But for Australia, there is little to be overly concerned about.
Playing The Market
Once again the strategists are in reasonable lockstep in the case of what to buy and what not to buy. Perhaps the most conformity lies in the belief that the US market is showing compelling valuation, despite the economy’s predicted further demise. The clear signal is that large cap US corporates with significant offshore exposure are something investors should be accumulating.
For Europe the opposite is true, as the European export sector is in serious danger. Japan is seen as an increasingly safe bet for modest improvement.
The only real dissent is in playing emerging markets, where strategists clash over whether the great Asian miracle is still worth pursuing at these levels. It is perhaps most prudent to say there may yet be some further blow-off in emerging market equity valuations due to their overbought state in the short term, and the likelihood of an easing of growth following the US slowdown. In the longer term however, the direction is still up.
Steer clear of Eastern Europe. The Eastern European economies are in the same position now as the Asian tigers were last decade.
For Australia, the mood is still positive despite the expectation of easing in some commodity prices. The same case cannot be made for bulk commodities such as iron ore and coal, however. The concentration of returns in the Australian market since 2002 has been in the resource and banking sectors. It is expected that the banking sector may be the next target for merger and acquisition activity, while M&A in resources will continue.
Which brings us to the last salient point.
Our strategists agree on the significance of “Chime” – China and the Middle East – and the substantial accumulation of wealth in oil-rich nations and booming economies. The new player on the block has already made its mark in 2007, and will only continue to become more prominent in 2008. The post credit crunch era will be the era of the sovereign wealth fund, much to America’s horror. The global market has no problem with liquidity – there is still plenty of money out there. It only has a problem with risk valuation and credit. But the governments of China and the Middle East have no such problems.