Darnell: Double-dip recession possible

NEW YORK Tue Dec 8, 2009 4:22pm EST

First Quadrant Chief Investment Officer Max Darnell answers questions during the Reuters Investment Outlook Summit in New York December 8, 2009. REUTERS/Lucas Jackson

First Quadrant Chief Investment Officer Max Darnell answers questions during the Reuters Investment Outlook Summit in New York December 8, 2009.

Credit: Reuters/Lucas Jackson

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NEW YORK (Reuters) - The U.S. economy may be headed for a "double-dip" recession if broad access to credit remains impaired, Max Darnell, chief investment officer of First Quadrant, said Tuesday.

Darnell, whose fund manages nearly $18 billion, also said the euro has likely topped out against the dollar and forecast renewed weakness in the U.S. real estate market.

"The concern we have is whether or not people have money to spend or money to borrow," he said at the Reuters Investment 2010 Outlook Summit in New York. "It boils down to the state of a variety of different balance sheets as well as the failure of credit to be extended in the way we need it to be."

Though data showed a sharp decline in the rate of U.S. job losses last month, which many point to as evidence of a healing economy, Darnell said private and government balance sheets remain in poor shape, and limited access to credit means less money "to deal with anything difficult that comes down the pike."

After four straight quarters of decline, the U.S. economy returned to growth between July and September, expanding 2.8 percent on an annualized basis.

But Darnell said the lack of credit creation stacks the odds against an easy recovery and leaves the economy vulnerable to a renewed downturn, in market parlance a "double dip" recession.

"What really sustained the Depression was the failure of credit to be extended," Darnell said. "We're facing the same thing today and we don't know how to resolve that."

GOING LONG U.S. DOLLAR

With corporate balance sheets in better shape, Darnell said First Quadrant had a light overweight position in equities, though he said the fund's posture was defensive and tilted slightly toward value over growth shares.

Other risks for investors include another leg down in the U.S. housing market, which stabilized slightly in recent months after falling 33 percent between July 2006 and April 2009.

As a hedge, he said the fund was long the U.S. dollar on the view that any lurch back into recession would provoke investors to cut exposure to stocks and other risky assets and park money in short-term dollar-denominated assets and cash.

That pattern saw the dollar rally in the second half of 2008. But after peaking in March of this year, it has lost some 14 percent as optimism about a recovery fed appetite for higher yielding currencies and assets.

Darnell said if growth does take a turn for the worse, an abrupt end to that strategy, which involves borrowing the dollar at low interest rates to finance more lucrative investments elsewhere, could be very messy for investors.

He said the euro has topped out against the dollar for now. The common European currency hit a 16-month high above $1.51 last month, not far from its all-time peak above $1.60.

High deficits in some euro zone countries have dented the appeal of European equities, Darnell said.

In emerging markets, he said currencies such as the Brazilian real presented a good opportunity for investors because the economy is not just a beneficiary of excess liquidity but is also supported by solid fundamentals.

With credit creation low, the trillions of dollars the U.S. government has committed to boosting the economy is not yet an inflation risk, though Darnell said that could change in years ahead, once the economy begins to gain traction.

Even so, he said he is not extremely pessimistic about the dollar's long-term fortunes. Many in financial markets worry that rising U.S. deficits and public debt will one day cause foreign investors to shun dollars for other currencies.

While Quadrant's current dollar bet is tactical, Darnell said "it's not obvious to me that the problems in the U.S. are worse than those elsewhere in the developed world. So whether or not we should be generally bearish on the dollar in our general sentiment within this business as we are, I think, is questionable."

Weak economies in the euro zone and an aging population in Japan are problems for the euro and yen.

He said he would not buy gold, which hit a record above $1,200 an ounce in recent weeks, at current prices, adding that the metal's meteoric rise is a reflection of concern about excess money in the world economy and fear about individual countries' solvency.

"There's very much a defensive characteristic to it," he said.

(Editing by Leslie Adler)

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