Recession is Unlikely

According to Giles Keating, Head of Global Research for Credit Suisse a recession in the United States is unlikely. While the U.S. economy is slowing down, fears of a market collapse are over-rated.

Below is an interview Joy Bolli conducted with Giles:

Joy Bolli: What is your take on the world economy at the moment?
Giles Keating: The world economy is not in bad shape at the moment despite the credit crisis. The latest data suggests there is a slowdown underway in the US and in Europe as well, which has hit a bit faster than expected. And, China and Asia are still booming. Even those slowdowns in Europe and America are looking unlikely to turn into recession, so the outlook at the moment is not unhealthy.

Is Switzerland also affected by this slowdown?
Well, Switzerland can't be immune because it is a big exporter, but overall I think the Swiss economy is looking pretty healthy. The likelihood is therefore that Switzerland will see a period of slightly slower growth, but the risk of it coming anywhere near recession are extremely low. Perhaps within nine months, or in even less time, we will see things accelerating again.

You mentioned Asian growth. How long can this growth be maintained in the wake of the US slowdown?
It looks, at the moment, that Asia will be relatively unscathed by the US slowdown. Given that we are not seeing the US go into an outright recession, and with US demand growth easing back a bit, the effect on Asia will not be overwhelming. In fact, it might help to reduce Chinese growth from almost 12 percent down to almost 10 percent, and that would still be a very rapid growth rate.

And how is that ongoing Asian boom impacting other regions?
The impact is profound. Throughout Asia, whether India, China or some of the smaller economies in the region, we are really seeing some of these countries becoming the power houses of the world economy. They are providing a lot of less expensive goods, which helps to keep the lid on inflation. They are also consuming a lot of raw materials and energy, which is pushing oil prices to high levels, as well as metals and food. That, of course, is bad for inflation and a problem that the rest of the world has to cope with. So, the growth is double-edged.

How should investors react to those rising commodities prices?
Commodities have been, and still are, in a long-term bull market, which could probably go on for a magnitude of another three to four years. Or perhaps even a bit longer. Of course there will be cyclical swings within that time and over the next two or three months, we might see a slightly slower period as a result of one of those swings. As a strategic matter, we do believe investors should have exposure to commodities. However, we certainly recommend that they do so through specialist funds, and we advise that they choose those funds pretty carefully. It is a matter of having a fund that is not too heavily weighted toward energy, which some are. Some are better diversified, and there are a number of technical issues to consider, such as the importance of roll-yield. Therefore, I recommend that investors take specialized advice to minimize the reliance on roll-yield in their commodity exposure.

Is there an inflation risk here?
At the moment, it looks as though the inflation risk is not great enough to prevent a Fed cut if it chooses to do so. The Fed and the other central banks must keep an eye on inflation, not least because of those energy and raw materials prices. Currently, those high resource costs don't seem to be feeding into other parts of inflation and this leaves the Fed free to cut rates again if they want to.

The markets have been rallying. Is this a trend that can last?
The equity markets have done very well since that correction was made in August. Since then, we have seen a strong rally and many markets are breaking new highs. I think that is due in part to the fact that for sustainable reasons, the valuations are still not particularly high and because the economic growth outlook, as we discussed, doesn't look bad. We've had a little bit of a slowdown, but overall it’s looking pretty good. In particular, emerging market equities have rallied as well as companies in the developed world that are exposed to the emerging markets. We think that can go on a bit more. It won't be a straight line, of course, but we think the valuations are still attractive and that the growth stories are still there. In addition, there is still liquidity there and a lot of investor money, and that combination can drive prices up further.

Looking to the US, its trade deficit has been falling. What does this reflect?
The decline in the trade deficit is an interesting development because people have been very worried about it for many years. What is happening now is that with the US economy growing slower at a time when the rest of the world - especially Asia - is growing rapidly, a good combination has been created for bringing the deficit down. The slower growth of the US consumer keeps the import growth down, and that strong growth abroad helps to boost exports. And the dollar's weakness is also a bonus because it helps to make US production attractive and competitive, and that further keeps the trade deficit down.

Do you think that the dollar weakness is set to continue?
I think it will. We are not expecting the dollar to see a really big decline, but we do think that the dollar could trade toward the 1.45 mark against the euro. Against the yen, the dollar might see a bit of short-term strength. Although as we get into next year, the dollar could start to weaken against the yen again along with some of the other Asian currencies. So, for the time being it’s a picture of the dollar staying pretty soft, however, the risk of having it collapsing isn't that high.

If the dollar is going to stay weak, is gold a good alternative?
I think gold is beginning to look a little bit expensive. As far as one can measure, it is at a high-level by historic standards when adjusted for inflation. We have been seeing ranges above 730 dollars per troy ounce, and those ranges are more of a holding area rather than a buying one. We do think that some of the other precious metals, such as silver and platinum, can also offer significant value. Those investors looking at precious metals out of concern about the dollar should place less of a focus on gold and more of a focus on some of those other precious metals.

What is your forecast for the bond market?
Quite a question mark remains for longer-dated bonds in the 10-year area and we are not really advising investors to go there. Certainly as we look forward several months, and as the economic outlook becomes clearer, we think there might be some upward pressure on some of those longer yields. However, for the shorter-dated maturities of two to four years in many of the major markets we feel reasonably comfortable with investors having a kind of core holding. Again, we don't think by any means that investors should aggressively hold fixed income rather than equities. We think it is equities that will outperform, but it is good to have an element of fixed income in a portfolio as a balance and that is the maturity range to have.

Can you sum up what all this means for investors?
It is still a healthy environment for investors. We believe that equity portfolios can do pretty well and we believe the credit problems have not gone away, but we do believe they are beginning to subside. There may be one or two nasty announcements yet to surface, but we think the larger parts of these announcements are behind us. It is a world in which the global economy seems in reasonable balance. Of course, there are always risks, including the risk of inflation from that very, very rapid growth in Asia, or the risk of the US or European economies slowing down too much, but at this moment we think that those risks are containable. This leads us to this healthy view for the equity markets, although we are cautious on the dollar and not so excited by the fixed-income world at the moment.