Market Outlook 2008(ZT)

Market Outlook 2008: Slowdown of the US Economy Leads to More Modest World Economic Growth

Global equity markets remain attractive in the long term, commodity prices are expected to rise, and inflation-protected bonds offer attractive diversification benefits

Zurich,  December 10, 2007

Next year, the world's economy will first of all be faced with a clear slowdown in the pace of US economic activity. Developing economies in particular will be put to a "decoupling test." Though these markets are not totally immune to a US slowdown, strong domestic economies are likely to cushion the effects of weaker growth in America. Credit Suisse also expects Europe to experience more moderate growth than in 2007. According to the bank's experts, a more conservative rate of growth is likely to dampen acute risks of rising prices against the backdrop of a latent inflation risk. Global equity markets are likely to remain attractive in the long term, though heightened volatility can be expected. In view of the rather low general level of interest rates, Credit Suisse recommends short to medium maturities. Inflation-protected bonds actively contribute to the income growth and stabilization of a diversified portfolio.

In 2007, the world's economy is once again likely to have produced robust growth of nearly 5%. Nevertheless, in light of rising energy prices, a renewed worsening of the situation in the financial markets, along with a continued correction in the American housing market, the risks to growth have once again increased - particularly for the US. Credit Suisse experts therefore believe the US will exhibit growth in real GDP of only 1.9 percent in 2008. The bank expects the US slowdown to have a dampening effect on growth in other regions as well. In the fast-growing economies (in particular China, the rest of Asia, but also selected countries in Latin America), however, these effects are unlikely to be as pronounced as in the past. Besides healthy investment prospects, high growth in employment and wages, together with rising equity markets and real estate prices, have strengthened domestic demand and in particular household spending.

Central Banks Face Growth as Well as Inflation Risks
Against the backdrop of increased risk to growth, Credit Suisse anticipates further, modest cuts in interest rates in the US. Nevertheless, the Fed's scope for cutting rates is likely to be constrained by the latent risk of inflation. While the Bank of England is likely to begin lowering rates in 2008, Credit Suisse analysts believe the European Central Bank will keep rates at the current level for the time being. The Swiss National Bank has repeatedly pointed to the inflationary risks posed by a depreciating Swiss franc. Given the greater volatility in the financial markets, these fears are unlikely to be compounded in the near term. For now, therefore, the threat of a further interest increase appears to have waned.

Dollar's Weakness Spreads to Asia
Central bank policy remains pivotal to the development of the US dollar. Against the backdrop of a US current account deficit that is financed almost exclusively by bonds, the marked narrowing of the dollar's interest-rate premium in the year now coming to an end is likely to put the greenback under further pressure. Nevertheless, European currencies such as the euro and pound sterling have risen well above parity. Over the coming year, a reversal of the transatlantic interest rate spread in the US dollar's direction could herald the start of a recovery for the currency. The Swiss franc is likely to possess further upside potential in the coming year. The financial market environment will in our view be characterized by more substantial exchange-rate fluctuations. The conditions for carry trades are therefore likely to become more challenging - hence the Swiss franc's potential to appreciate over the coming 12 months, not only against the euro but also against the pound. Investors with the Swiss franc as reference currency would therefore be well advised to hedge gains on their foreign currency positions.

Commodities: 2008 Should Be Another Strong Year
The onset of the US mortgage crisis heralded a significant change in the fundamental outlook for commodities. The dollar's subsequent weakness together with cuts in US interest rates have propelled prices of many commodities to new highs. This situation is likely to ensure commodity prices to go on rising in 2008, especially with the world economy likely to continue growing at a moderate pace. Nevertheless, in light of economic uncertainties in the US, investors will need to get used to the idea of more substantial fluctuations in prices for individual commodities and higher volatility in overall terms. In these circumstances, investing in commodity indices would appear an increasingly attractive option. In terms of individual commodities, it is gold and agricultural commodities that are likely to offer the greatest potential gains.

Real Estate: Cyclical Opportunities in Asia, Focus on Core Investments in Western Markets
2007 marked the turnaround in the real estate boom of the past years. The changing environment in the global credit markets should further impact the direct real estate markets in the quarters ahead. Temporarily diminishing capital flows are expected to cause capital values to stagnate or even decline in the months ahead. This applies above all for many Western markets with rich valuations, such as London and Madrid, where office yields have already started to shift outward again. We think that this trend is not over yet and discourage investors from opportunistic short-term investments in those markets. Over the medium term though, we expect robust capital flows into real estate to rebound and markets to deliver attractive total returns again. For the time being, we therefore recommend investors to concentrate on core investments that generate stable and strong rental income in the year ahead. Our preferred region for 2008 is Asia, where selected real estate markets are expected to offer robust performance in the commercial as well as the residential sectors. Among them, Singapore is our favorite for 2008.

Equity Markets Remain Attractive, but Greater Volatility to be expected
Global stock markets will enter the new year supported by attractive valuations. Credit Suisse's equity strategists expect positive stock-market returns for 2008, though persistent uncertainties regarding the tight situation in credit markets and US consumer spending are likely to ensure increased volatility in prices. Over a 12-month view, our preferred regions are Europe, Asia, and selected emerging markets. In the latter case, we favor markets with specific drivers: The Chinese stocks listed in Hong Kong ("H shares") are benefiting from ample inflow of liquidity from Chinese private investors, while the Gulf states and Russia are beneficiaries of the persistently high oil price; meanwhile, Brazil is attractive due to strong growth in its exports to Asia. Within Europe, restructuring plans and recovering consumer demand offer sustained upside potential for Germany; the effects of this will also be supportive to markets in France and Switzerland.

Investing in Megatrends
Credit Suisse analysts continue to advise investors to invest in selected megatrends that are likely to play an important role in the medium term. Infrastructure, water, and alternative energy sources are still perceived as offering major potential thanks to global trends: A growing world population and increasing integration of countries like China and India into the world economy are likely to continue fueling demand for infrastructure and energy in the coming years. The consequent lasting increase in energy prices should continue to boost the attractions of alternative energy sources such as solar and wind. Drinking water is also becoming an increasingly scarce commodity due to a growing population and overuse, making vast investment in water infrastructure inevitable over the next few years. Technological advances such as those in nanotechnology are also likely to provide further investment opportunities.

Bonds: Short Maturities and Inflation-Protected bonds
With central banks weighing growth slowdown against rising prices, the trend toward a steeper yield curve - that is, a generally higher term premium - is likely to characterize much of 2008 on bond markets. Short to medium-dated maturities still appear appropriate in light of the rather low general level of interest rates. Inflation-protected bonds, which benefit from falling real interest rates and rising inflation, should continue to perform positively and actively contribute to the enhancement i.e. stabilization of diversified portfolio returns.

Focus on high-grade issuers
Corporations' credit metrics are likely to deteriorate while financial market volatility remains high and the prevailing liquidity shortage recedes only slowly. Credit Suisse's experts are therefore focusing on high-grade issuers in the (semi-)public sector and on agencies in the credits spectrum. Covered bonds with a transparent asset pool and a clear legal framework are also among the recommendations, as are selective debtors in the energy and industrial sectors. Bonds from the financial sector are likely to be exposed to further volatility in the near term, and must be assessed in a differentiated way. In the emerging markets, the fundamental data of many government debtors has improved markedly. Russia and Brazil are among the debtors favored by Credit Suisse analysts. Even if emerging market bonds undergo bouts of widening spreads amid heightened market volatility, long-term investors are likely to view the high yields as attractive by international standards.

Enquiries:

• Dr. Anja Hochberg, Head of Global Economics, FX, Commodities & Real Estate Research, Tel. [phone], [e-mail]
• Lars Kalbreier, Head of Global Equities & Alternatives Research, Tel. [phone], [e-mail]
• Dr. Nannette Hechler-Fayd'herbe, Head of Global Fixed Income & Credit Research, Tel. [phone], nannette.hechler-fayd'[e-mail]
• Media Relations Credit Suisse, Tel. [phone], [e-mail]