Business Times Singapore Investment Roundtable
2010: A year of recovery or more crises?

William R. Thomson
Dec 24, 2009

Experts offer differing views, with some predicting 2010 to be a difficult year and others saying it will see recovery continuing

PANELLISTS

Eisuke Sakakibara: Former Japanese vice-finance minister for international affairs, now professor at Waseda University, Tokyo

Mark Mobius: Executive chairman, Templeton Asset Management

Robert Lloyd-George: Chairman, Lloyd George Management, Hong Kong

Ernest Kepper: Former senior official of the International Finance Corporation (IFC) and Wall Street investment banker who now heads an Asian financial consultancy

William Thomson: Chairman, Private Capital Ltd, Hong Kong, Director, Finavestment Ltd. and senior adviser to Axiom Funds, London

MODERATOR

Anthony Rowley: Tokyo correspondent, The Business Times

OVERVIEW

THE world escaped from a financial meltdown and a new Great Depression more easily than many dared hope in 2009. Asia in particular bounced back faster than expected, thanks largely to huge fiscal and monetary stimulus in China.

The situation in the world's most advanced economies was also stabilised by massive government spending, financed largely by central banks printing money. Will 2010 be a year of further recovery, fuelled by reviving private demand, or will it be the 'year of reckoning' when double-dip recession and deflation appear, and when debts shifted from the private to the public purse have to be paid?

The Business Times assembled a panel of eminent and seasoned experts to review economic and investment prospects.

Anthony Rowley: Welcome to this year-end Investment Round Table as we gather for the last time in 2009 and look ahead to what lies in store in 2010 - the Year of the Tiger inthe Chinese zodiac. Some say it is a good year for taking risks, and there seems to be no shortage of those. Prof Sakakibara, would you begin the crystal-ball gazing and tell us what lies in store.

Eisuke Sakakibara: 2010 will be a very difficult year. Among developed countries, including the United States, the economy will be very weak and there is even a possibility of a double-dip recession. In the case of Japan, the likelihood of a double-dip recession is around 50-60 per cent. The situation (in Japan) is very bad at this moment. In the US case, fiscal stimulus will probably continue until the summer of next year but around the end of the year there is a possibility of a double-dip recession. Europe too has a very serious situation. Being a collection of countries, the situation is even more difficult than in the US. European countries have separate policies and economic conditions are different, yet monetary policy is unified.

Deflation is going to continue, not only in Japan but also in the US and Europe, and it may deepen. The so-called 'Japanese disease' is going to be a major malaise among developed countries. The problem is that it's not a monetary phenomenon - it's a structural phenomenon arising mainly from globalisation. So it's very difficult for central banks to control and it will take a long time to work its way through the system.

William Thomson: I agree that the crystal ball is cloudier than usual. The global economy did indeed escape a cataclysmic collapse of the financial system a year ago and the heart attack was treated with previously unthinkable doses of adrenaline in the form of unorthodox monetary and fiscal policies. After a lag the patient has returned to consciousness but is in far from rude health.

In many ways, the developed world is suffering from what Japan has suffered from since its bubble burst. Much as has happened with Japan since 1990 - good years have followed bad only to relapse into further bad years, I expect the efforts made in 2009 to show fruit in 2010 with decent positive growth in OECD countries. The real question is the sustainment of that recovery into 2011 and beyond, as and when stimulus measures are gradually withdrawn. For the US, 2.5 per cent growth is certainly possible after almost two down years. But the recovery will be tepid as consumers still have to rebuild battered balance sheets and unemployment will stay unacceptably high - about 18 per cent, if you include part-time and discouraged workers who wish to work full time. The outlook for 2011 is even less certain with tax increases expected to take effect and be a drag on growth.

The UK should be much the same with concerns that the incoming Conservative government will slow things further by slashing government expenditure to set course for a healthier economy in four to five years' time. A double-dip recession is a real possibility for the UK. Europe will be mixed, with France and Germany moving ahead, while others struggle with indebtedness.

Asia, as usual, will be the bright spot with China and India the stars moving ahead at 6-8 per cent, but with rapidly increasing concerns in China about overheating and bubble formation. I expect there to be inflation scares, especially early in the year when comparisons are made with last year's low prices for oil and other goods, but overall it should be contained in 2010 with real concerns rolled forward to 2011 and 2012.

Ernest Kepper: 2010 will be a year of severe economic contraction. The (overall global) economy will not improve in the next six months, with high unemployment, the US federal budget deficit, and an increase in taxes as the top concerns. Massive injections of central bank liquidity have prevented the collapse of financial markets, but have done little to ease the de-leveraging of households or stimulate activity in the broader economy. The fiscal strangulation of the millions of people who are no longer considered 'creditworthy' is progressively weakening demand and spreading pessimism across all income levels, even as the US shows signs of moving from recession to recovery. Forced personal thriftiness is reducing economic activity and strengthening deflationary pressures, leaving many families with little to spend at malls.

Debt deflation and de-leveraging will continue into 2010, while foreclosures, personal bankruptcies and defaults continue to mount. The credit collapse and the accompanying deflation and overcapacity are going to drive the economy and financial markets in 2010. Perhaps inflation is a consensus forecast but deflation is the present-day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years.

The maximum impact of the stimulus has already been felt, and additional stimulus will be no more than US$200 billion, of which a mere US$50 billion will go towards jobs initiatives. At the same time, Fed chair Ben Bernanke will terminate the quantitative easing programme which kept long-term interest rates low while providing financing for the housing market. When the programme ends, rates will rise, housing prices will tumble, and liquidity will drain from the system. The end of quantitative easing coupled with dwindling stimulus ensures that economy will slide back into recession in the second or third quarter of 2010.

Rowley: Very sobering thoughts. But I think others see a little more good cheer. What about you, Mark?

Mark Mobius: I think 2010 will be a year of recovery. Company results and country economic results will be better than in 2009, although not as good as 2008. Employment will gradually improve but companies will focus more on productivity and thus will not engage in exuberant hiring. Inflation will not come back immediately but will gradually move up by the end of the year, provided that the money printing presses continue to roll.

Robert Lloyd-George: I also think that 2010 will continue the economic recovery which has begun in the last few months of this year. Our macro forecast shows a strong turnaround in the Asian economies from negative growth last year in Hong Kong, Japan, Korea, Malaysia, Singapore, Taiwan and Thailand, to an average of 4 per cent growth in 2010, and an acceleration in growth in China from 8.3 to 9.5 per cent, India up from 6.1 to 7.5 per cent and Indonesia, from 4.5 to 5.5 per cent.

But we see inflation rising everywhere, with the possible exception of Japan, and reaching double digits in India and Indonesia in the second half. Although China currently anticipates its CPI to rise by under 3 per cent, our private forecast is for it to exceed 5 per cent by the summer (rising food prices are a major factor). Employment figures will continue to improve in most countries, even in the USA, where we expect (President) Obama to produce a second large stimulus programme before the midterm elections in November.

Rowley: How great are the dangers of fiscal crises erupting in 2010 and what would be their impact on the wider investment universe?

Lloyd-George: My biggest fear is indeed a crisis in one of the major bond markets - Japan, the UK or the US, or one of the weaker countries of the European Union such as Greece, because debt-to-GNP stands at between 100 and 200 per cent and fiscal deficits are unsustainable, and perhaps un-financeable.

It is however possible for a country to continue for an unexpectedly long period with large deficits and finance them from domestic savings. (Japan is the prime example). However I do expect that bond yields will rise from their very low level during the next 12 months and that this could have an impact on equity markets.

Mobius: We are already seeing fiscal crises in Greece, Portugal and Dubai. There will be other countries all over the world which have found it necessary to expand spending could have problems in balancing budgets. The impact will be a heightened sense of vulnerability and a desire to move to 'safer' investments.

Sakakibara: I would not call it a crisis yet but if it continues on as it is now that would be a major problem for Anglo-Saxon countries in two or three years. They have to start thinking about exit policies. In the US and UK, there is a fiscal problem but in the case of Japan I don't see any problem in the short run because although the accumulated government debt is very large - around 170 per cent of GDP - accumulated household savings are equal to 280 per cent of GDP. We could expand fiscal policy probably to avoid a double-dip recession. This would involve issuance of government bonds but they would be absorbed by the markets. There is abundant liquidity and risk aversion is widespread, so lots of demand for government bonds.

Thomson: As we have seen recently with Dubai, Greece and Spain, fiscal crises can be expected to occur during the course of 2010. Whilst they may give plenty of jitters, and there will be further downgrades, it is more likely than not that EU countries will work their problems out. There will be talk about countries leaving the euro but I do not believe it will happen in 2010. The solutions are likely to be draconian and only increase unemployment further leading to social unrest. The UK is on a path to a ratings downgrade unless it cuts its deficit and moves to a more credible fiscal path. A Conservative government, if it is elected next spring, will try to begin that process at the cost of massive unpopularity as programmes are cut and taxes increased. Re-election of Labour could see the UK headed back towards the IMF as happened in 1976. The US faces similar dilemma and massive middle-class tax increases may be voted for 2011, including a substantial capital gains tax increase. These should have a negative effect on the US market as 2010 progresses.

Rowley: So what does all this mean from the point of view of bond-market investors? What are the attractions, if any, of fixed-income markets, and where are interest rates headed in 2010?

Sakakibara: Fed chairman Bernanke has said that he will maintain a low interest rate for some time to come and I think that will probably be necessary because the recovery is very weak in the US and the same thing could be said about Europe. In the case of Japan, I think that again the low interest rate policy will be continued. (Generally), I would not see any major hike in interest rates until late next year. Maybe after next summer, if the recovery is robust, there is a possibility for example in the US of the Federal Reserve raising rates but that's very uncertain. Deflation will continue, and that is bad for bonds.

Mobius: Interest rates will probably edge up in 2010 and the attractions of the fixed-income markets will come down to logical levels.

Lloyd-George: The only fixed-income markets that I think are attractive are Australia and Norway. Interest rates will go up nearly everywhere.

Thomson: I am not a fan of fixed-income markets believing there to be an oversupply of sovereign credits and the 30-year bull market has essentially come to an end. I believe we are still facing a version of the 1970s stagflation and, indeed, governments, especially the US and the UK, would like to see some inflation in the system to reduce the overburden of the outstanding debt. At some point, possibly in late 2010 and no later than 2011, interest rates on 10 to 30-year US Treasuries will begin to reflect these facts and move higher.

Rowley: What about currencies? Prof Sakakibara - or perhaps I should call you 'Mr Yen' in this context - what do you see?

Sakakibara: I think that the yen will probably appreciate towards 80 in terms of the dollar and 120 in terms of the euro or even 115 or 110. Japan can live with that although it would be a very difficult situation for some exporting companies. As for the dollar, there has been a slow decline of the dollar for some time against all currencies but now the euro has weakened a little. So in terms of the euro, I think it will be par but against other currencies the dollar will probably decline. I think the US government is supporting a gradual decline of the dollar and the US balance of payments situation is improving. I am not seeing a crisis for the dollar - whether (its descent) is controlled or not I don't know but the US welcomes this development. Some of the Asian countries are shifting from the dollar to the euro or to gold and that is generating a gradual decline of the dollar.

Kepper: The unwinding US dollar carry trade is the most dynamic trend for 2010 where financial crises could erupt. Basically the US dollar carry trade consisted of going short the US dollar and long on very highly leveraged equities and commodities. This direction of change could be very significant as it could result in the US dollar rising sharply against most currencies, especially the commodity-related ones with the drop in prices of equities and commodities.

Rowley: Now let's turn to equity markets - emerging and developed. Where do you see these going in 2010, and why? Let's start with you, Mark.

Mobius: Equity markets simply will go up, because liquidity in global markets is so high and because emerging economies are growing so rapidly.

Lloyd-George: We expect that emerging markets (Brazil, India, China, perhaps Indonesia) will continue to outperform on the basis of strong commodity prices, strong economic growth, political stability and stronger currencies. They all have healthy foreign exchange reserves and a surplus on trade. Much of the improvement in the developed markets in the US and Europe has already happened, although I would venture a guess that the good multinational blue-chip companies, such as Coca-Cola, Johnson and Johnson, IBM, are still very undervalued, relative to world markets.

Sakakibara: The performance of US corporations is improving but at the cost of layoffs. Unemployment is rising and consumption is very weak. Still corporate performance is relatively good so I would not expect any major decline in the New York Dow Jones index. The Nikkei average (in Japan) will probably decline.

Thomson: To paraphrase John Pierpont Morgan: Markets will be volatile. Markets have bounced back impressively - as they did in 1930 only to relapse in 1931 - since their March lows and are overvalued on many fundamental criteria.

This reflects a certain flight from cash as governments have gone on a wilful binge printing with abandon. A pause, even a reaction, here would be healthy to allow fundamentals to catch up with prices. There is plenty of cash on the sidelines waiting for such a reaction, which should contain the downside.

There is a chance that this will happen since we see some firmness in the US dollar, reflecting problems in the euro zone and some at least temporary cooling in commodity prices. This, I believe applies to both developed and emerging markets. Emerging markets are no longer cheap but they still have superior growth prospects to developed markets and they have undervalued currencies, so there is a double play there. Developed markets will be affected by the prospects of tax and interest rate increases.

Rowley: What about the outlook for gold, and also for other precious metals and commodities in general?

Lloyd-George: I have been continuously promoting investment in gold for several years. I expect in the short term it will reach US$1,300 per ounce, and will reach US$5,000 per ounce over the next three to five years. This price (by 2014 or so) would imply a collapse of faith in the dollar and eventually a political crisis leading to a restoration of the gold standard in some form. Other commodities will continue on their upward path also until 2014, especially the lagging soft commodities, such as corn, wheat, sugar, rice, beef, coffee, soya beans and palm oil (cocoa, today, is at a 25-year high).

Other precious metal prices such as silver and platinum will outperform gold and I expect copper and the industrial metals will remain strong as long as China's infrastructure spending continues and India's follows.

Mobius: The outlook for gold and all commodities is good and we expect high prices (over time) but (the rate of) price rises will be moderate.

Sakakibara: There will be some selling of gold if it goes towards US$1,500 so I would not anticipate a continuous rise in the price. I am not seeing a crisis for the dollar - whether (its descent) is controlled or not I don't know but the US welcomes this development. Some of the Asian countries are shifting from the dollar to the euro or to gold and that is generating a gradual decline of the dollar. That is going to continue.

Thomson: Gold is also not as cheap as it was but I expect it to continue to gain credibility as the only asset that is not someone else's liability, that is, governments cannot print more gold - although I should note that there are a growing number of scams in the field and it is rumoured that a considerable number of tungsten-filled bars are circulating and some have been found in central bank vaults. So care in buying physical gold is essential.

Gold now has a new class of buyer: central banks. India has made a major purchase from the IMF at US$1,050 an ounce and it should act as a floor. China is adding to its reserves from its domestic production. It owns 1,000 tonnes but the US owns 8,000 tonnes and the EU 12,000 tonnes. With China becoming the second largest economy in the world and probably No. 1 by about 2025, it is reasonable to assume China would aim to own between 5,000 and 10,000 tonnes in 15 years' time. Other Asian countries have too many paper dollars and too few tonnes of the yellow metal. That is long-term support for the metal and supports arising price. Silver is underpriced relative to gold and so makes an interesting addition to portfolios. Gold and silver shares are interesting on any pull-back (in price) since they are still selling the same price as when gold was US$800 two years ago.

Kepper: Gold is operating on its own particular set of global supply and demand curves and should be an outperformer, especially when the next down-leg in the US dollar occurs. Gold should be bought and held for at least three to five years, as we are at the beginning of a new cycle for gold accumulation. The long-term trend is still up for the price of gold.

There are two basic motivations to invest: greed and fear. As more and more defaults occur from real estate, corporations, and governments in the next few years, trust in domestic and international financial systems alike will diminish as it becomes obvious that there are insufficient funds to service large amounts of outstanding debt that was issued over the last decade, and the price of gold will rise without any real inflation present. Then inflation begins, and as the price of gold continues to rise, fear is replaced by greed as the primary reason to hold gold bullion.

Gold-mining stocks are riskier than owning bullion as there are dangers from fire, flood, resource depletion, and nationalisation. But as gold prices climb, so do the prices of stocks.

Moreover, many gold stocks average 15 per cent dividends. If your net worth is between US$100,000 and US$1 million, 25-50 per cent of your assets should be in gold and silver. Of the gold, a rough breakdown would be 60 per cent in bullion and coins, 30 per cent in gold mining stocks, and maybe, if you have the appetite, 10 per cent in penny stocks.

Rowley: What about other investment opportunities in 2010 - real estate, for example?

Mobius: Emerging markets still represent the best opportunities in my view.

Lloyd-George: Real estate is certainly an interesting area given my inflation outlook, but it is of course a local phenomenon. The Asian real estate markets will do best, although I, like others, am concerned about the development of a bubble in Beijing and Shanghai, where prices are already very high. The easy availability of capital and of mortgages and low interest rates will continue to support strong property prices in Hong Kong and elsewhere, as well as the weakness of the US dollar. I noticed on my recent trip to China a 'land rush' similar to the 'gold rush' which we see in other communities around the world.

Thomson: Residential real estate in the US is a bargain for patient, cash-rich vultures. Commercial real estate, on the other hand, is a slow-motion train wreck. Residential property in the UK is still expensive and despite the hurrahs of the industry has probably got some way to go on the downside as unemployment increases and financing remains challenging for first-time buyers. Asia, however, is a bubble in formation especially China and Hong Kong. The authorities are aware of the problem and are increasing down-payments but may be behind the curve. Foreign investors may have a double whammy of higher prices and higher local exchange rates.

Kepper: In order to preserve wealth and manage risk, I believe the dominant focus should be on capital preservation and income orientation, whether in bonds, hybrids, hedge fund strategies, and a consistent focus on reliable dividend growth and dividend yield would seem to be in order ever off the commodity sector.

Rowley: Let me close by wishing our panellists - and all of our readers - a happy - and hopefully prosperous - New Year.

This article originally appeared in the Business Times Singapore.

Dec 24, 2009
William R. Thomson
email: wrthomson@private-capital.com.hk

William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.

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