Beware The Other Shoe

Being a bear in the bull market years wasn't easy, but David Roche stood his ground. With markets off their peak, he's still bearish--and feeling vindicated. The former head of global strategy and economics for Morgan Stanley Dean Witter, Roche runs Independent Strategy, a London-based investment adviser to hedge funds, corporations, and Middle Eastern and Asian governments. He spoke with BUSINESS WEEK's London bureau chief, Stanley Reed:

Q: Your bleakest recent predictions have not come to pass. World markets have not fallen 30% to 40%; Brazil has not collapsed. Did you get it wrong?

A: Some of our forecasts have been wrong, but a bevy are still waiting to happen. We had the decline in the Western markets right. We got the emerging- markets crisis right. [Financial collapse in] Brazil and China has not happened. [The collapse of] Brazil, China, and South Africa and the second leg down of the bear market have been put on hold.

Q: Why?

A: We are living in a kind of dream period now. The Fed is bailing out the world. Japan is about to print 60 trillion yen [$500 billion] to prop up banks and give $30 billion to $100 billion to Asia without any conditionality. The weakened dollar has given emerging markets a huge sigh of relief. The International Monetary Fund is ready to spend money on anybody it thinks is worthy that might have a crisis. These factors have led to a dramatic rally, but they are temporary--they might last for three or four months. Most of the dream world will start to end before the end of the year.

Q: What is the outlook for the U.S.?

A: It is going to be the least recession-struck economy in the world. The U.S. will go to a growth rate of between zero and 0.5%.

Q: Will Federal Reserve Board Chairman Greenspan cut rates some more?

A: Financial markets are saying he will cut 25, 25, 25 [basis points], but Greenspan may hold off for a month. The consumer has not caved in. But I still think the U.S. will slow, and he will cut rates.

Q: How should a U.S. investor allocate assets now?

A: Thirty percent stocks, 50% bonds, 20% cash. There will be an opportunity to buy equities cheaper. I still think the Dow will go to 6000.

Q: Would you buy Japanese equities?

A: No. The valuations are wrong, the outlook for the economy is dreadful, and the state is bankrupt.

Q: What's your prognosis for the euro?

A: The euro is going to be a weak currency. The idea the euro can replace the dollar is out of the question. The politics of Europe are moving the wrong way to make it an attractive place for foreigners to put their money.

Q: How about European stocks?

A: I would not touch European stocks or bonds except in Britain. Europe could have a surprise recession with left-wing governments that don't have a clue what to do about it.

Q: Are there markets you like?

A: Australia and New Zealand. You can get 5% dividend yields in Australia and 8% in New Zealand. They will come to enjoy safe-haven status.

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