Saxo – the bank, not the salt company – predicts that Western financial markets will undergo a ‘Japanization’ effect, which will result in higher price earnings ratios and lower yields on both corporate bonds and treasuries. And the reason: the need for continued monetary stimuli and the long term government deficits?

David Karsol, chief economist at Saxo Bank, said:
“Because Western economies are more flexible and able to embrace the necessary changes, we do not think that things will get as bad as was the case in Japan. However, it is increasingly evident that the current scenario in the West bears a close resemblance to post-1990 Japan, and it looks progressively like we have entered a new regime in which everyone assumes that large companies will be bailed out. This means that default risk is ‘priced out’, and we see higher price-to-earnings ratios and lower yields on fixed income.”

Saxo Bank, which is a Copenhagen-based investment specialist, goes on to predict that in the fourth quarter of 2009, the American economy will return to positive GDP growth in the second half of the year, but warns that the sustainability of this growth is questionable and will be largely due to government spending and inventory restocking. Also, US unemployment will continue to rise over the coming months, and that this will further hinder debt repayments and consumption.

And Mr Karsol believes a USD short seems to be a vote for the global recovery and has become the, newer and better carry trade. He said:
“The very low US’s yields and need for external financing and increasing reluctance from China to buy greenbacks is a toxic cocktail that could drive the currency even weaker in the near term.”

As regards the end of the year, Saxo Bank believes that market dynamics indicate a shift from this year’s equity market rally. Global equity markets rallied 59% from the March lows through to August, and looking ahead, Saxo Bank thinks that the core dynamics indicate a shift in performance towards micro trends and sector-specific growth and valuation stories.

Mr Karsol again:
“Most indicators of economic activity are stabilising, but at very depressed levels. We believe investors should continue to take cyclical risk through regional allocations, with particular emphasis on emerging markets over Europe and the US, where it will be difficult to maintain and improve growth.”

For those interested, Saxo Bank has offices in Australia, Amsterdam, Athens, France, Italy, Japan, Singapore, Spain, Switzerland, UK, and the United Arab Emirates.

Guest Article by Neil Camp