Over the next few months, some black clouds are likely to continue hovering over global markets and portfolios.
The global economy is expected to slow somewhat over 2008 but is still likely to keep growing at an above average pace, bolstered by continuing strong growth in China and other parts of Asia see accompanying graph.
The US economy has certainly been hit by a sharp slowdown in its housing sector but other sectors have kept performing relatively well and expectations of a sharp US recession which would have slowed down global growth in general have receded.
Global inflation is also likely to remain under control, despite the recent oil price hikes and the sharp rise in Chinese inflation which will be passed on to the rest of the world via price rises in many Chinese exports.
However, the US sub-prime storm clouds will continue to threaten market stability.
Worldwide, banks may lose as much as $US400 billion from sub-prime mortgages, as at least one in four of the risky US home loans go into default, analysts have predicted.
For example, an analyst at Deutsche Bank Securities Inc, has estimated there will be $US150 billion to $US250 billion of losses based on $US1.2 trillion of US sub-prime loans, and an additional $US150 billion of losses on derivatives linked to sub-prime debt.
This is likely to further effect global bank share prices and further disclosures of big losses by major banks would add to the already high instability being displayed by global markets.
However, Australian bank exposure to these problems is minor and domestic growth is likely to keep powering along nicely over 2008.
Furthermore, despite a likely global slowing, most commodity prices are likely to remain strong over 2008, largely as a result of continuing strong Chinese demand. This will keep a very solid floor under resources share values and the ASX.
In short, the global economy and markets outlook is looking somewhat sunnier than it was just three months ago.
Indeed, the US storm had three silver linings.
The first was its impact on market risk expectations.
For some time, it had been clear that the US and some other markets were holding too optimistic a view on risk.
Thus, what the sub-prime mortgage storm did was to illuminate the exposure some very big financial institutions such as UBS, Merrill Lynch and Citigroup had to high risk credit instruments and thereby force a healthy re-assessment of financial market risk premia.
The second silver lining was that the storm showed that the major central banks are willing to take quick, concerted and effective action to reduce the effect of such storms.
Indeed, the cut in US interest rates will help prevent a serious US slowdown in 2008, unless further disclosures of massive bank losses occur.
The final such lining was the re-think beginning among the world's major central banks about exactly what changes in regulation and supervision are required in the new world of derivatives and much more complex financial instruments. (This is discussed in depth in a just-published RBA volume.)
What could be the next lightning bolt over the next few months? Certainly expect further market-scaring disclosures from the US sub-prime fiasco.
But the $US also deserves close watching.
Having reached record lows against other major currencies recently, a calamitous collapse in it would send Wall Street crashing dramatically and the US Federal Reserve would be unable to cut interest rates further because such cuts would merely send the $US falling even further.
Ominously, a senior Chinese politician recently called for his country to get out of "weak currencies" and if it did in a major way that would tip the $US over a very dangerous edge.
However, a dramatic sell off of the greenback by China and the world's other major holders is unlikely.
In sum, there are plenty of black clouds hanging over world markets but the fact that the US problems did not produce a financial cyclone is a salutary reminder that investors should not be distracted by inevitable bouts of lightning but instead take a much longer view of the investment climate.
Dr David Clark taught Business Economics at the University of NSW for 35 years, was an AFR and Personal Investor columnist for over a decade, and is now an investor educator. The views expressed are those of David Clark's, not necessarily those of Vanguard's.
