Here at the headquarters of Seven Investment Management, we in the investment management team are renowned for our rather pessimistic economic views and are affectionately called the ‘doom and gloom corner’. Mostly we wear this badge of honour with some pride and take comfort from the fact our cups are always half empty (incidentally, what’s the difference? Half empty, half full, at least we can all agree that the cup isn’t full yet!) However after spending the last two days trapped in a building (where I just happened to be attending the Euromoney Bond Congress) with fellow bond investors, chief investment officers and chief economists of some large investment managers, speakers representing the OECD, the Treasury of the United States, Central Bankers (the list is endless but distinguished), I came to this conclusion. We in the investment team are now faced with an identity crisis! Compared to the doom mongering I have listened to, we are positively full of sunshine and roses!

Coming to the conference, one view that found accord amongst most participants and evidenced by the idiot-proof manner of a show of hands was that the US is now in recession. Barring a couple of speakers representing the American government who refused to believe this was the case (echoing an episode of the TV show ‘West Wing’ where White House staffers were banned from using the R word and instead called it a bagel!), most acknowledged that it certainly felt like a recession, with one American speaker despairingly stating that he has now been dragged kicking and screaming into believing that the US was now in recession. The chairman then promptly delivered a “if it feels like a recession, smells like a recession, then it’s a recession” and drew his final line under that debate! Here at 7IM, we also believe that the US is heading into recession and that today’s hangover from yesterday’s overindulgence is likely to last for some while yet as the consumer now starts to fix his household balance sheet. This process of adjustment will take longer than that endured by the corporate sector in the previous recession of 2001. The fiscal package promised by President Bush will kick into the third and fourth quarter GDP numbers but will remain a band-aid for a bullet wound. Naturally, amid the current environment, government bonds are finding keen demand in the developed world.

While this period of uncertainty has thrown up problems in the sub-prime mortgage sector, widening spreads in the credit market, banking sector turmoil and more recently problems in the monoline insurers, many are waiting for the next shoe to drop. Other doom scenarios mentioned were a fall in the commercial real estate prices in the US, trouble in structured products followed by possible capital outflows from mutual funds that contain such structures, and continuing default rates in sub-prime mortgages.

Attention also focused on the much talked about and feared inflation. Perhaps not all that surprisingly, a larger percentage of the audience were more worried about inflation, than not. On the same note, the majority also opined that the Fed’s credibility was damaged with Bernanke being behind the curve and now taking his eye off the inflation ball, much to the chagrin of the assistant secretary for economic policy at the United States Treasury department! Mentioning both the widely held view that commodity prices both hard and soft are on a long term incline, along with ending of favourable shocks from China, a rise in its export prices and appreciation of the Renminbi, Roger Bootle of Capital Economics told of his concern in the rise of inflation over the next year but said it would be followed by a period of disinflation, if not outright deflation.

Turning to the rest of the world, neither Europe nor Asia escaped the blows taken by the recession believers. Europe’s problems lie in housing problems in Ireland and Spain, downside risks exacerbated by the European Central Bank’s focus on ‘inflation to the exclusion of everything else’ and the full impact of overvaluation of the Euro against the Asian currencies yet to come through. At least someone mentioned that a strong Euro did take the edge off rising commodity and raw material prices!

Asia was questioned on its abilities to withstand a US consumer led downturn having not done so before. But it probably would not surprise you to learn that the Asia supporters were out in force, backing their enthusiasm with theories of decoupling or as one speaker suggested ‘insulation from the US economy’. What’s a conference these days without mentioning the two giants – India and China? GDP growth is predicted to be around 8% and 9% respectively even given a recession in the US due to a pick up in domestic demand, growing investment in infrastructure, the luxury of being able to slow down an over-heating economy through fiscal and monetary policies. So what are the options? As many Asian currencies appreciate versus the Dollar, buying local currency bonds or sovereign wealth funds as a hedge against the Dollar is possible. As bank lending increases in countries like India, these institutions are providing opportunities to buy high quality credit paper and more non-financial companies are now also looking foray into the arena. If you are happy about the macro-economic and corporate sector outlook, can stomach the liquidity and political risks in these sectors, then the overwhelming message seems to be along the lines of that Sharwoods commercial sung to the tune of the famous song Go West - ‘Go East, Chinese, India, Thai,  Go East, There’s so much to try, Go East!’

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And finally……….The UK’s first energy saving day when E-Day asked people to switch off electrical devices they did not need over a period of 24 hours, apparently ended with no noticeable reduction in the country’s electricity usage. By that account, there was presumably no noticeable reduction in the country’s energy bill either. Given the imminent recession and forecasts of consumers having to fix their balance sheets, I guess we will just have to find some other painless way of doing so, preferably one that doesn’t involve switching off our heating or lights, getting in our car or pulling the plug from our TV sets!

Have a good week,

Aparna Ram
Research Analyst
Seven Investment Management Limited