Global Warnings

Dubai World—a government chooses not to back $26 billion in debt and world markets shudder. Cash for clunkers ends and auto sales crater. Construction stimulus money dries up and the trucks grind to a halt. Housing credits expire and so do sales. What happens when governments, which have been so instrumental in propping up key global markets, begin to withdraw?

And has all that exogenous influence faked out the markets? Keith Hembre is the chief investment strategist and head of the team that manages the international equity, asset-allocation, index, and quantitative strategies for Minneapolis-based FAF Advisors. Hembre also has taught economics at the St. Petersburg University of Economics and Finance in St. Petersburg, Russia. Here’s what he thinks.

When you look at the global picture, how much perfection are the markets pricing into it, particularly on the debt side?

I think quite a bit more on the equity side than on the corporate credit side. Obviously, you’ve seen a substantial improvement on the corporate credit side, but spreads there [the difference in yield between corporate and U.S. Treasury securities] are still wide on a historical basis. The flip side of that is that if you look at the equity market, depending on the segment of the market, the valuations relative to current earnings are quite high—and they’re still pretty high as to expected future earnings.

How real do you think any eco-nomic recovery is? It seems any time a government prop is taken away, that sector begins to suffer.

A central tenet of our forecast is that we’re going through a spurt of activity in the second half of 2009 that will probably carry into the first half of 2010, and it reflects just what you describe: the temporary effect that the stimulus program is having on growth, along with private-sector dynamics related to the inventory cycle and special effects to some sectors, such as autos and housing, that are beneficiaries of incentive programs.

That said, a significant portion of the private-sector adjustment is behind us as far as the contraction in residential construction goes. We probably have a ways to go in terms of contraction in commercial construction.