By Dian L Chu

Correction Triggered by QE2?

Democrats "sadly enough" would get a shot at still retaining the majority, which would mean the monetary and fiscal policy will most likely stay on its current course.

Equity has done well in September and October months; however the markets are stretched in the inflation trade, and weak dollar, high commodity and precious metal prices, along with high equity valuations, all suggest a correction is overdue.

Now, with QE2 being largely priced in, anything less than $1 trillion from the Fed would disappoint the markets and may trigger a correction in U.S. stocks, which could result in more quantitative easing.

But the correction should provide a buying opportunity for investors leading to an up cycle, instead of another bear market.

Equity Better for the Next Decade

Looking at investing for the next ten years, equities, emerging economies in particular, would be a relatively better place to invest than U.S. government bonds, and cash. However, the view is against financial, auto, and aircraft, while favourable should be the high tech sector and likes Microsoft (MSFT).

Precious Metals Due for Pullback

Agriculture commodities and the accumulation of precious metals is recommended. Precious metals are overdue for "some kind of correction" by year end, and expect the next leg up in 2011.

Dollar Near An Inflection Point

Dollar is oversold, while in contrast, some of the foreign currencies such as Yen and Franc are overbought. So, an inflection point could be near for a short-term dollar rally which could temporarily push down asset prices.

Investors are warned to be very careful about shorting dollar and long assets as the trade has become quite crowded.

Expect a Strong Pullback of Chinese Economy

Although not quite a gloom and doom, there is an expectation of a "strong pullback" on the Chinese economy due to its many imbalances.

The 0.25% interest rate hike effective October 20 by the PBoC is "meaningless," because of skyrocketing property prices, and the cost of living inflation has gone up much more than the official figure.

He notes food prices have seen high inflation, and because of low GDP per capita, where food would account for a high percentage of total expenditure, it is estimated that the typical consumer inflation rate in countries like China, India, and Vietnam should be around 8 to 18% per year.

Marc Faber, publisher of the Gloom, Boom & Doom report, discussed the potential impact of further quantitative easing (QE2) by the U.S. Federal Reserve in a Bloomberg interview on October 36 as stated above.

My Take on China Inflation

The inflation rate in China was last reported at 3.60% in September of 2010, climbing at the fastest pace in two years. However, there are some hidden rampant inflation such as 50% on apparel, 20% on food, as reported by BusinessWeek.

Many analysts as well as academics also question how China could have such relatively moderate inflation rate given its double-digit growth and upward pressure on wages. Michael Pettis, a finance professor at Peking University, for example, estimates that "Inflation could well be 6% now for most people in China."

There's also another indicator - growth of money supply, which has a proven strong correlation with inflation. China's money supply, M1 and M2, has expanded by 56% and 53% respectively over the past two years. Currently, with the various tightening measures, both money supply figures are still growing at an annual rate of about 20%, based on Bloomberg data.

Furthermore, the continuing massive rural-to-urban migration will likely keep pushing up rents and food prices, just to name two of the many categories, and wages are expected to rise around 8% this year.

As consumer inflation is typically a lagging indicator, China may experience continuing higher CPI. That means Beijing is facing an increasingly difficult task of containing inflation, while maintaining sufficient growth to prevent a mass civil unrest. As such, there will likely be more tightening, which would put the markets on a few roller coaster rides in the next two years or so.

Nevertheless, since Chinese policymakers are keeping a close inflation watch, and are already taking actions (which is the key); I believe China is heading towards more sustainable growth. And if China is "on a treadmill to hell" as Jim Chanos says, you can bet that the United States will be dragged along for the ride as well.

From Economic Forecasts & Opinions