The Analyst: The East has cash, the West has debt
Saturday 26 January 2008
I am writing this article on Wednesday, some 24 hours after the US Federal Reserve surprised the markets by cutting interest rates by 0.75 percentage points. Many commentators have suggested that this was an attempt to rescue the equity markets, but I don't actually think that is correct.
In my view, the move has much more to do with helping "monoline" insurers – these are companies that insure the debt of other companies, and they are themselves running into trouble. If they start going belly up, then we could enter a new and more dangerous leg of the credit crisis could start. In the end, the US government could have to step in as a final guarantor.
There is an awful lot of bad news already priced into the markets, so the question is how much worse things will get. I really have no idea whether we will go into recession, although a poor housing market in the US is going to be a significant drag on growth for some time.
History suggests that if the US and Europe do go into recession, then company earnings could fall by as much as 33 per cent, and stock markets usually fall by about 25 per cent during these periods.
Given that our own stock market is around 20 per cent down since its peak, we could be within around 10 per cent of the bottom. I am grateful to Julian Chillingworth, the chief investment officer at Rathbones, for these statistics.
I think the events of 2007 and so far in 2008 mark the start of a gradual shift of economic power from the West to the East. Our credit problems are home-grown, with consumers and governments alike mired in debt. It is interesting to note that central bank reserves in the US total about $55bn (£28bn), and that last year they fell by about 2.5 per cent. By contrast, the cash reserves of the Arabic Gulf States alone rose by 40 per cent last year to $1,000bn.
You might have noticed that most of the US banks (Citigroup, Merrill Lynch etc) have been bailed out by sovereign wealth funds from the developing economies. It is now the developing world that has the cash and the developed world that has the debt.
However, this kind of change brings opportunity with it. Four-fifths of the world's population lives in the developing world, and much of it is industrialising at scarcely credible rates and creating wealth along the way.
In my view, these economies are not totally "decoupled" from the US economy, but I certainly believe that they are better insulated from a US recession today than they were even a couple of years ago. I also believe that falls in these markets represent excellent entry points for long-term investors prepared to take a 10-year view on their investments.
The demand for oil will grow as Asia and other emerging markets continue to industrialise and urbanise. You simply cannot turn off major infrastructure projects overnight, and I am sure that the price of oil won't fall simply because the UK economy gets squeezed.
I wouldn't advise that you sell all your investments in Western markets, but it seems likely that 2008 will be a tough year. Interest-rate cuts alone will not solve the credit problems, and they are unlikely to fuel extra consumer spending as money will be needed to pay off debt and to pay higher fuel bills.
The long-term opportunities seem to lie in the developing world, and I have already covered some of the top funds in these pages. I would reiterate my view that the JM Finn Global Opportunities Fund is an attractive option. The manager focuses on the infrastructure projects – such as power, toll roads, rail, shipping and pipelines – that are vital for the emerging market industrial revolution to continue. This could be a profitable, if somewhat volatile, area to invest for the next 20 years.
In conclusion, I don't think that we are out of the woods yet. We can only relax when we are able to trust the banking system (and banks are able to trust each other) and we know where all the liabilities are.
So; fasten your seat belt for a bumpy ride this year, but if you focus on the long-term potential of global markets you should be able to weather the turbulence.
Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent
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