Debt May Sink Stocks to Crisis Lows, Says First State

The stimulus-driven global economic recovery is threatened by excessive corporate and government debt that may push global stocks to below their post-credit-crisis lows, said Alistair Thompson of First State Investments.

That suggests a drop of more than 34 percent for the MSCI World Index from yesterday’s 1,051.60 closing level. This could occur within the next 18 months, according to Thompson, who co-manages First State’s Asia Pacific (ex-Japan)/Global Emerging Markets fund. First State managed about $126 billion as of December 31, according to its website. The fund is skewed toward “defensive” stocks, he said.

“We’re anticipating much slower economic growth in the coming period,” said Thompson, who is based in Singapore. “There’s a distinct possibility global markets could return to, or fall below, their bear-market lows. The big problem at the moment is government leverage, bank leverage, and in some places, consumer leverage.”

The MSCI World Index tumbled 59 percent from its record high of 1,682.35 on Oct. 31, 2007, to a 14-year low of 688.64 on March 9, 2009, after Lehman Brothers Holdings Inc. collapsed, triggering a financial crisis that precipitated a global recession. The gauge rallied 70 percent through the rest of 2009 as governments spent more than $2 trillion in fiscal stimulus to spur economic growth, aiding a worldwide recovery.

“The initial remedy was piling on loads more debt,” said Thompson. “But it’s odd to think you can solve a debt crisis with more debt. At some point, you have to wean yourself off.”

Aggressive Tightening

Already industrial countries are embarking on the most aggressive tightening of fiscal policy in more than four decades.

Rich nations will reduce their primary budget deficits, excluding interest payments, by 1.6 percentage points next year, the most since the Organization for Economic Cooperation and Development began keeping records in 1970, according to JPMorgan Chase & Co. economists. The budget squeeze will cut 0.9 percentage point from growth in 2011.

The problem of excessive leverage is less in Asia than in more developed markets, according to Thompson.

“Asia is economically in much better shape,” he said. “The problem is that the region is still heavily dependent on developed markets for exports, so we’re not immune.”

The MSCI World Index has lost 10 percent this year through yesterday as European sovereign debt crises, China’s steps to curb asset bubbles, and worsening U.S. growth indicators threaten to choke off the recovery.

China Growth

Goldman Sachs last week cut its full-year 2010 forecast for expansion in China’s real gross domestic product, while the latest reports on U.S. manufacturing, employment and home sales pointed to slower growth in the second half of the year.

This year, concern has also grown that European countries in addition to Greece will struggle to curb their budget deficits or repay debt. The MSCI Asia Pacific Index fell today for the fifth time in seven days after slower-than-estimated expansion by U.S. service industries added to speculation global growth is faltering.

First State’s Thompson says his fund is waiting for markets to fall further before modifying the “defensive” posture it has held for the past three years.

The fund is geared toward less risky investments, said Thompson, with about 12 percent allocated to gold companies, more than 10 percent to telecommunications stocks, and roughly 14 percent to consumer-staples-related firms.

“Since the beginning of 2007, we’ve had very little exposure to banks or commodity companies, with the exception of gold,” he said. “Our portfolios are probably as defensively positioned now as they’ve ever been. But we’re always looking to pick up some real quality at bargain prices.”

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