2008 outlook for currencies, stocks and commodities

When purchasing power gets out of whack, as is currently happening in the US, it makes the news. However, there are many factors other than currency movements that can lead to a rebalancing of purchasing power parities. Let me explain.

When I arrived in 1973 in Hong Kong, I frequently asked when people quoted me prices if they meant US dollars or Hong Kong dollars. Prices were simply so inexpensive. At the time you could take a fairly long taxi drive for less than one US dollar.

But what happened thereafter was not that the Hong Kong dollar appreciated against the US dollar but that inflation in Hong Kong exceeded US inflation for so long that in the end the Hong Kong dollar was devalued against the US dollar by more than 40%.

Profit outlook

Since both commodity prices and interest rates peaked out in 1980/81 it is safe to assume that the principal cause for the profit margin expansion in the 1980s and 1990s were meaningful declines in interest rates and commodity prices.

However, in the current environment where cost pressures are becoming more common because of rising commodity prices, while at a time when revenue growth is slowing down, corporate profits are likely to disappoint over the next twelve months or so and put pressure on equity prices.

As of late November, stock markets around the world became very oversold. With the prospect of the money-printing Fed cutting interest rates further and now also with other central banks likely to follow the Fed, stock markets have begun to rebound.

The rebound is likely to last until around the turn of the year whereby new highs will most likely not be achieved. Thereafter, stocks should resume their downtrend as it will become evident even to the diehard optimists that the economy is already in recession and that corporate profits will contract further.

New Year sell

Therefore, we would use further strength in equity markets as a selling opportunity (for the S&P selling is recommended on a rebound to around 1500).

On balance, conditions for a dollar rally have improved and a shift from Euros into dollars or a long US dollar position versus the Euro or the British Pound is recommended as an intermediate trade. As mentioned before the easier trade may be to buy the Yen against the British Pound or against the Euro.

I am cautious about industrial commodity prices, which could come under pressure as global liquidity growth and the global economy slows down. And while I still think that gold will outperform equities in the years to come I believe that a more meaningful correction in the price of gold is now underway.