Don’t panic. It’s just sogflation, says L&G

Legal & General is “cautiously optimistic” on market prospects, although it noted the global economy has entered a “sogflation” phase of soggy growth and stubborn inflation. Sogflation is the worst part of any cycle for corporate profits, said James Carrick, investment strategist at L&G.

Most central banks want to curb growth, warned Carrick, with the global economy running above full capacity. He predicted few would follow the Fed’s example after its recent rate cut of 0.5%. The Bank of Japan has explicitly stated it wants to raise rates and the European Central Bank, having just raised rates, is unlikely to reverse this move now, said Carrick.

The Bank of England, he predicted, will leave rates on hold until next year, and then reduce them to a neutral rate of 5.25%, probably in May 2008.

The rude health of emerging markets, showing more strength than ever before according to an IFO world survey, will help keep the global economy out of recession, Carrick said. Emerging markets have shown decoupling from the US: many have current account surpluses, he noted, meaning they have reduced exposure to the expected US slow-down.

He noted emerging European economies may be a better bet than their Asian counterparts, having less exposure to corrections in China and India.

Carrick said the fears of some about the US economy are overdone, predicting growth of 1.9%, (below a consensus expectation of 2.4 %.) “I think US consumers are smarter than people think,” he said, predicting many home-owners have negated the impact of rising rates on their floating rate mortgages by refinancing with fixed rate mortgages.

Therefore extreme potential eventualities, a full-blown recession or double digit growth, are unlikely, Carrick said, predicting slower growth in the low single digits in coming months. He said market consensus has over-blown profits and interest rate cutting expectations, but said equity market valuations were in many instances still attractive.

Where government bond yields rise above the absolute rate of return in an economy it historically indicates economic distress, noted Carrick, witnessed in 2000 and both the early and mid 1990s. Although G4 bond yields briefly peaked above the OECD nominal potential GDP curve this year, he noted they have again fallen below, indicating the global economy is safe from full-blown recession.