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Derrick: No Double Dip, But Growth Will Slow

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. We're reporting from the 2010 Morningstar Investment Conference. And I'm here with John Derrick. He is a Director of Research at U.S. Global. It's a boutique advisory firm, and he has some expertise in government policy, and some municipal bonds and treasuries. He's here to tell us a little bit about his overall take. Then we're going to talk about some individual investment and asset classes.

John, thanks for joining me.

John Derrick: Thank you.

Stipp: First question for you, there's a lot of mixed signals in the market right now, some on the plus side. Corporate earnings have generally been stronger than expectation's recently. We're seeing still some strength in manufacturing, in the recovery, but there are some dark clouds in the horizon as well. We're seeing valuations that have run up quite a bit over the last year. The government debt and sovereign debt has become an issue in Europe and people are wondering about the U.S. debt problem. And we're also concerned about stimulus removal and what does that mean. This has a lot of folks talking about the possibilities for a double dip. Is that something that's on your radar, is it a distinct possibility right now?

Derrick: Sure. I think the double dip scenario is probably unlikely. I think what we have seen though, you are right, earnings have been pretty good. I think the economic recovery has generally been stronger than people had expected, but now, I think, you're getting to the point where those manufacturing indicators that you mentioned, a lot of those are actually starting to show signs of a decelerating rate of change.

You are seeing that also in some of the leading economic indicators as well. They're still up, but at a decelerating rate. And I think that shows you that the economy is at an inflection point. And we've talked about or you mentioned a little bit about some of the just global issues that are going on, particularly the austerity measures that are coming out of Europe, I think, are going to, obviously, be a drag on growth.

We had China just recently revalue their currency modestly, et cetera, but that's going to be a very modest drag on growth in China, but I think it impacts globally. And then here in the States, not so much at a federal level, but more at the state municipal level, you actually have quite a bit of a belt tightening going on as well. Either taxes are going up or budget deficits just have to be cut and reduced, and you have to balance your budget, and those kind of things and that's just going to reduce spending.

Actually, I think that's one area that maybe investors are overlooking right now, is how much austerity measures are going on here in the U.S. And so because of those factors I think over the next several – two or three quarters, I think economic growth actually could disappoint. I don't think a double dip. I don't think that's in the cards really. We have extremely low interest rates, very supportive monetary policy. So, I think a double dip is not likely, but I think you could get 1.5% to 2% growth instead of the 3% growth that a lot of people are expecting.

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Stipp: So a question then from the market's perspective and what the market seems to be expecting based on valuations. Do you think if we do see some disappointing figures that the market might take a hit, is it expecting something a little bit better than maybe we might get?

Derrick: Sure. Actually, definitely I think that's part of what the selloff that we've seen recently. I think people are readjusting their growth forecast, but honestly I think there's probably a little more adjustment that needs to be done that's my view. And so, I think during the summer over the next several months anyway I think the market could possibly chop around a little bit, trying to figure all those kind of factors out. See how things actually are going to play out. So, I'm not gloom and doom on the market or anything, but yeah, could we trade a little lower or could we trade in a range over the next several months? Yeah, I think that wouldn't surprise me.

Stipp: You had mentioned before about some of the belt tightening and some of the austerity measures that have to happen. I think one of the things on an investor's radar domestically is the Fed's exit strategy. So, unprecedented action by the Fed during the downturn that has to unwind at some point. How big of a risk is that? And you've had a lot of history watching the Fed and the policy, what's your take on the plan and the difficulty of enacting it when it's time to enact it?

Derrick: Right. Going back just a few months ago, I would have thought the Fed would have started an exit plan by now, but obviously things have changed and the world is just not as robust economically as we would've thought or I would have thought a few months ago.

So, I think the Fed's exit strategy has been delayed considerably. It's probably middle of '11 at this point to be totally honest. And so I think it's so far in the future or far enough in the future that I don't really have a good sense on exactly how they're going to execute that exit strategy, other than to say that, we're probably at zero interest rates for quite some time.

Stipp: Yeah. I think the Fed keeps saying over and over again extended period of time?

Derrick: Extended period and I think they're going to be right on that.