This is an issue regarding the US. The key beneficiaries of the rally that has emanated from the easing provided by central bankers in the West are in Asia. To me, this rally will become very vulnerable next year, once it becomes clear that this is not a normal recovery. In the short term, market movements are a matter of guesswork, but I think the risk of a correction in the S&P 500 is at its highest now, since March this year, primarily as the index has moved below its 50-day moving average. I feel that if we correct now on the S&P, the correction will be less severe than if the index were to run up to 1,200 by the year end and then corrected. Fundamentally, I think that the excess liquidity generated by Western central bankers will benefit Asian asset prices. The key thing for me is that the S&P is in a bear market, whereas Asia is in a bull market.

How do you see the US economic recovery in the next six months?

The US has seen three quarters of declining nominal GDP; the last quarter was helped largely by the inventory cycle. Going ahead, in the property market, a lot depends on what the government does on the tax credit for first-time home buyers. The extension of this programme will help stimulate the economy in the short term (Since this interview, the Obama administration has extended the tax credit until May 2010). The risk reward in both the cash for clunkers, as well as the extension of the tax credit for home buyers is important because they are buying future demand. The US is not an emerging market and it’s not like there are tonnes of people entering the market to buy new cars and the like. I think the stimulus programme has had its effect, though. In that sense, the US recovery is contingent on the extension of the tax credit, given that we may have already seen the best of the inventory cycle.

So you don’t believe that there is a need to upgrade the earnings cycle?

The current earnings upgrades in the US have been driven by aggressive cost cutting by corporations, not top line growth. While there is nothing wrong with that, if the trend of earnings upgrades being driven by cost cutting continues, stock markets may start getting concerned. The low top line growth indicates weakness in nominal economic activity.

How do you see Asian economies, particularly China and other export-dependent economies performing in 2010, if the US continues to under-perform?

Asia is currently the best growth story in the world with the best fundamentals and high savings rate. Plus there is income growth, small levels of consumer debt and lower levels of corporate debt. I expect Asian economies to be more resilient. I think a good number for Chinese growth is about 8 per cent. India will also be resilient this year, but whether India will grow at 7-8 per cent of GDP requires more concrete progress on the whole infrastructure investment module.

How do you expect Chinese equities to perform over the next year?

I am overweight China as well as India. However, the Shanghai market has had a correction and I am reducing the weight of India simply because it has performed so well, and over the next few months you may see markets getting concerned about monetary tightening measures. In terms of China, I am going to remain over-weight with a focus on domestic demand stocks.

What impact will the withdrawal of stimulus measures have on equity markets in the region? Will it affect foreign fund flows?

Serious talk of withdrawing stimulus will cause markets to react and this may force the governments not to withdraw these packages. I don’t think there will be a withdrawal of stimulus actually. Money will flow to all of them or to none at all. To put it differently, I think foreign investors will be interested in putting their money in China, India and Brazil.

You’ve a target of $3,360 per troy ounce for gold. What factors will drive it to that level? And what about oil?

I’ve had that view since 2002 and that target remains. The driver for higher gold prices has to do with growing investor concerns on the paper currencies in the West, particularly the dollar; and inflationary policies undertaken by most Western governments and countries like the US which have undermined the credibility of government guarantees. Also, the lack of alternative reserve currencies, other than the dollar, is why I expect gold to go up significantly. Commodities like oil have done very well; they have had a big rally. Demand from China has played a big role. In an equity correction oil may go back to $50-55 levels.

Where according to you is the dollar headed?

The dollar is currently acting as a carry trade currency. It is the new funding currency of choice for investors who want to buy equities with borrowed money. I believe that once equities correct, the dollar will rally. There is a 0.95 inverse co-relation so far this year between the S&P 500 and the dollar index.

Do you expect this new round of carry trades to result in asset bubbles?

If the current stance of monetary policy in the West is continued for a year or more, then the risk of asset bubbles in Asia will be much higher. The issue then will become one of finding the best way to pre-empt it. Asian policymakers are addressing that risk. My guess is that we will see only incremental moves in Asia, not aggressive ones. Asian policymakers can stop this bubble risk if they are aggressive, but they may not want to be too aggressive.

Do you expect the yen to gain further against the dollar?

The yen is a tricky one to answer, since I could argue both ways. In the short term, there is a risk that the yen will go up against the dollar. In the long term, the risk is that the Japanese government debt blows up. The global carry trade business may then move from the yen to the dollar. On the policy front, it makes sense and such policy is long overdue. But how will they finance it? They don’t have enough room to manoeuvre fiscally since government debt is on the higher side.

CLSA Strategist Christopher Wood