Europe to lag, Asia to lead

Europe is heading into troubled times, predicts the well-regarded investment consultancy GaveKal.

It is starting to experience "the full effects of higher taxes, higher interest rates and a higher exchange rate" a combination "usually enough to floor even the toughest economy (which Europe is not)."

Fiscal tightening has cut economic growth by 0.7 per cent in the Eurozone over the past couple of years. Interest rates have doubled. The Euro is two-thirds more expensive in dollar and yen terms than it was six years ago.

Leading indicators are now worse than for the US, despite the latter's highly-publicized problems. Retail sales in Germany, the biggest European economy, are running well below last year's level. And judging by the actions of the European Central Bank, European financial institutions are being hit especially hard by the global crisis in credit markets.

After previous financial crises, "Europe has usually turned out to be a weak link in the global economy," says GaveKal, due to "lax management in state-run or protected financial institutions" and reactive rather than pro-active monetary policies.

Two big risks for Europe now is that its global export markets will weaken the US foreign trade balance is already improving markedly - and that nations with huge trade surpluses such as China cut back their investment in European government bonds.

"The Euro should fall sharply," GaveKal predicts.

The consultancy reckons that inflation fears will soon subside and the world is now heading into a period of "mild deflationary boom." The places for investors to be will be Asian equities and real estate especially in Hong Kong and shares of the best multinationals.

"Investors in Asian assets are today sitting in a very comfortable position. They will either see massive currency appreciation and a boom in domestic consumption, or they will witness large liquidity injections [in the global financial system by central banks] which almost de facto guarantee a sharp rise in asset prices.

"We see a high probability of strong gains in Asian assets over the next two years.

"The fact that Asia has just experienced its strongest upward corporate earnings revisions in three years and that current stock price valuations do not reflect this very positive earnings momentum also reinforces our optimism.

"The Asian bubble has not even started!"

By Martin Spring in On Target, a private newsletter on global strategy