2007 to be a tough year for emerging markets: CLSA

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Jim Walker, Chief Economist at CLSA says that 2007 will be a tough one for equity markets. He says that the risk appetite of US investors towards emerging markets will decrease.

 

He further adds that the US economic slowdown will impact emerging markets, and he sees US interest rates coming down in 2007.

 

Excerpts from CNBC-TV18's exclusive interview with Jim Walker:

 

Q: Economically speaking, how do you approach 2007 - with trepidation or with optimism?

 

A: We always speak economically; I am afraid we approach it with a degree of trepidation and our crystal ball looks decidedly murky at the moment, not the least in the United States where we think the economic activity is slowing down at a rather rapid pace, which is then going to affect the rest of the world.

 

Q: Do you think in that sense it could be a tough 2007 for financial markets, or that the markets might move in a tangent in various parts of the world to what is happening with the US economy at large?

 

A: I think that the year aheda is going to be tough. This year has been a very interesting one, somewhat peculiar to say the least that we have seen good amount of interest in the emerging markets in particular.

 

All things US, whether it be investment funds, individuals, or companies, have been looking at putting money in offshore projects. And this is not limited to the US, but obviously Japan as well as other parts of the global economy are also included. The internationally strong and developed countries have been putting money into the emerging markets.

 

But when economies slow down in the home countries and economic conditions become more difficult, it is usual for them to take money away. And I think that is what we are going to see next year from America - the risk appetite is going to decrease.

 

Interest rates are eventually going to fall on the back of weaker economic activity and, which will mean less liquidity flows around the world. It is going to be a tougher year all round. I don't think we can decouple from what is happening in the US economy, neither can an emerging market or Indian markets elsewhere do that.

 

Q: You don't think lower interest rates, whenever they start coming down in the US, might compensate a bit for the lower amount of economic growth which might release some more liquidity into these markets? Do you think things will pan out like that?

 

A: The fact of the matter is that when interest rates begin to fall, they begin to fall for a specific reason, which is when economic growth and activity becomes disappointing. When that is the case, then all sorts of things tend to happen underneath the weakness in the economy.

 

For example, bad debts begin to rise in the banking system and we are already seeing some of that in the US; the housing market is obviously leading the way in that respect. 

 

But bad debts begin to rise; as a result, bankers and financiers become less comfortable with taking risks. So when interest rates fall, going into an economic slowdown, liquidity dries up. So the argument that interest rates will cushion the blues for everybody else is a very fallacious one.

 

Actually, falling of interest rates for that particular reason - usually economic activity slowing down - is accompanied by reduction in liquidity with asset prices falling.

 

Q: From what you have seen so far, it doesn't suggest that we may get away, as seems to be the consensus right now, with a bit of a soft landing?

 

A: I am worried with the consensus being bullish as it appears at the moment. Obviously we are seeing a tremendous end to the year in stock markets. They are all up and going significantly higher over the course of last two weeks of the year.

 

But volumes are beginning to slide somewhat and are being pushed up by money that just wants to make sure that the year closes at highs and the stock funds are good performers and they can justify their performance fees.

 

I think going into the early part of next year, we may see a much more considerate approach to stock markets where they certainly won't be going up as quickly and people will begin to worry about the outlook for the global economy.

 

The prospects of a soft-landing in the US is possible, as one can always say that things are possible. But what has been used to achieve the growth of the last four years has been a tremendous build-up in household debt in the US as well as a build-up in corporate debt, which is very unusual for this part of the cycle.

 

You would really need to be looking at monetary, credit and debt expansion of an order never seen before for this to be a mid-cycle slow down. So the alternative is that there is going to be a much harder landing than the markets are considering at the moment.

 

Q: A large part of the financial market puzzle lies in the dollar - how do you place it for 2007?

 

A: We are seeing a much stronger yen and reasons for that are much more peculiar to Japan. We expect interest rates to be rising relatively slowly and expect political pressure from around the world to start focusing on Japan rather than on China.

 

Japan really has the weakest currency in Asia by a long-long way. That is going to push the yen up but against other currencies, I think the dollar will actually stay pretty much where it is just now, if not strengthen somewhat. And that is really a reflection of Americans becoming much more centric towards their own country.

 

When the economy slows down, the US tends to pull dollars back into its own investments at home and that is what we are going to see. But with the exception of the yen, I wouldn't be looking for strong currency gains anywhere else in the world relative to the dollar next year.