With an economic recovery underway and clear signs that the credit crisis has ended, investors should look to equities for strong long-term investment prospects, according to Patricia Croft, chief economist at RBC Global Asset Management.

Speaking at a compliance conference in Toronto on Tuesday, Croft said many positive signs in the economy have emerged in recent months. She pointed to firmer commodity prices, a flurry of merger and acquisition activity, a rally in stock markets and significant improvements in credit markets.

“There is cause for celebration,” said Croft, “we are in the midst of an economic recovery.”

She added that signs are showing that the appetite for risk is increasing, which bodes well for equity investments: “Ultimately, this environment, of an improving world economy and end of the credit crisis, is still very supportive of risky assets.”

Croft warned that investors could see some near-term pullback in equities given the scope of the recent rally. She said stocks could decline by 5% to 10% in the months ahead. But she noted that most market indices remain 30% to 40% below their prior peak, indicating strong long-term prospects.

“There’s lots of scope for stocks to continue to rally,” she said. Croft added that she does not consider equities expensive in terms of their average price-earnings ratio.

“Despite that significant bounce-back in stock prices, indeed I think equities as an asset class are not that expensive,” she said.

Croft considers government bonds expensive as an asset class, and sees little potential for returns given historically low interest rates. Provincial bonds and corporate bonds, however, present better investment prospects, she said.

In terms of the form that an economic recovery will take, Croft does not expect the “double-dip” recession that some economists are predicting. Rather, she calls for a “growth recession” in which growth will be modest and will remain below historic levels for an extended period of time.

She said the recession has had profound impacts on consumer spending habits, particularly in the United States, which will continue to weigh on economic growth. She said there has been a notable decline in spending at restaurants and on gambling, as U.S. consumers have begun paying down debt and boosting their savings.

The U.S. personal savings rate has surged from 0% to 4% of disposable income this year, representing the fastest rate of growth in the history of the U.S. economy, Croft said.

“This is going to continue to be a drag on an economic recovery.”

She does not expect the U.S. Federal Reserve to raise short-term interest rates until 2011.

Croft is more optimistic about the prospects for the Canadian economy. She expects the unemployment rate to rise above 9%, but she pointed out positive economic developments in recent months, including a massive rebound in home sales.

She expects the Canadian dollar to reach parity with the U.S. dollar in the months ahead.

“I think we’re going to parity; I think we’re going to stay there for a long period of time,” she said.

But Croft warned that she does not consider parity between the two currencies to be sustainable or justified. Given the productivity gap between the two countries, she considers US85¢ a fair value for the Canadian dollar.

Of all the countries around the world, China is set to emerge the strongest from the recession, according to Croft.

“I think China will ultimately emerge as the biggest winner from this economic and credit crisis,” she said. She noted that the global economic recovery has largely been led by China, partially thanks to major stimulus spending. But despite massive stimulus spending, China is set to record a debt to GDP ratio of just 20% in 2010, representing a level significantly lower than countries such as Canada, the U.S., the U.K., and Japan.

Over the next decade, Croft expects Asian consumers to be a major source of economic growth.

IE