Stay Positive and Hedged

By Yiannis G. Mostrous

Absent any major shock, the global economy should deliver growth of around 4 percent next year--a key to the performance of emerging markets.

Economic numbers in China, the main story of 2009, should remain strong and should be enough to bolster satellite Asian economies. The latest reading of the Chinese Purchasing Manager Index (PMI) jumped 0.9 percentage points to 55.2, the strongest reading since April 2008.

The new orders index increased 1.8 percent to 58.6, while the output index went up 1.3 percent. External trade also contributed to the economy’s growth; the export orders index jumped 1.2 percent to 54.5. At the same time, demand for imported products, especially the furniture and oil refining products components, remains strong and suggests that the imports base is broadening.

If these numbers remain elevated, the Chinese economy should sustain its momentum into the end of the year and at least the first quarter of 2010.

Of course, continued economic growth will force the government to make some difficult decisions regarding monetary policy. On that front the Economic Working Conference, to be held in early December, should provide the first indications of how Chinese leaders plan to normalize monetary conditions.

Analysts currently expect the Chinese authorities to lower lending quotas for next year from USD1.5 trillion to around USD1 trillion.

The expectations for now are that the Chinese will choose the path of lowering lending quotas for next year from the current USD1.5 trillion to something closer to USD1 trillion. Policymakers have followed this approach in the past, as cutting interest rates is still regarded as a drastic move by Western investors even though China’s command banking sector blunts the impact of any economic fallout.

On the currency front, a confident Chinese economy and a better global economy will allow China to let its currency resume its gradual appreciation against the USD. Bearing this in mind, an appreciation of up to 5 percent next year should not be ruled out.

But what is also very important for the global stock markets is how the US will perform; stock markets worldwide remain fairly positively correlated to the US equities, even if their economies don’t march in step.

The US economy has the potential to surprise in the context of avoiding a “double dip” next year. If this is the case, US corporations should do well as they remain underinvested and have shed big parts of their labor force.

True, US policies are creating problems that will challenge the long-term health of its economy, namely big deficits and higher taxes.

The jury is still out on these issues, as the US government has not, as of yet, presented a comprehensive plan to address these issues. But investors should remain calm for now--these issues may not after all turn out as disastrously as the entrenched bears believe.

Imagine the market reaction when the state of the US economy proves to be much better than the majority now expects it to be. As of now, conversations with investors and market observers around the country indicate to me that they’re much more bearish than conditions warrant. Eventually we may reach the situation where a less bad outcome is the right outcome--at least for the markets.

That being said, third-quarter earnings in the US have been surprisingly strong, and inflation is nowhere to be found as wages remain low compared to historical standards. At the same time, the weakness in consumption has allowed US households to increase their savings, which is never a bad thing in the long term. 

On the investment side, cyclical stocks have performed well, catching up with defensive names. They should still do well, especially in Asia, but investors should start looking at some defensive plays--I favor consumer staples names with exposure to Asia. Investors should also look for stocks that offer solid and sustainable yields because dividends bolster total returns over the long haul.

Asian companies, contrary to the popular belief, offer some of the most sustainable dividends in the global market place. Coupled with their growth potential, this makes investing in the region even an attractive proposition for the serious long-term investor.