After a 21/2-year hiatus the bear is back, judging by the devastation in equity markets in recent weeks. Emerging Europe, Russia and Pakistan, among others, have been mauled in what many analysts believe is the first of many beatings to come as sentiment shifts in the face of successive United States interest-rate increases. ABN Amro strategist Eddie Wong echoed his fears in a mid-week report which cautioned investors to 'get out of risky assets' owing to growing concern the supply of new dollars could slow and even reverse, sparking a flight for safe havens. 'We believe the long overdue bear market has started,' he says. 'Sentiment has clearly been damaged, and it will be difficult to repair the damage in the near term. Any rebound is a sell in our opinion.' Anxiety over the impact of rising US interest rates has been building in recent weeks, as data pointing to rising inflation stirred talk the US Federal Reserve may drop its 'measured' programme and accelerate the pace. Last Tuesday the Fed boosted rates a quarter point, the seventh consecutive rate rise. Since the tightening began, US interest rates have risen 175 basis points and may now be approaching a threshold where speculators will abandon the practice of borrowing dollars to invest in higher-yielding foreign markets. 'One major risk is that if the massive dollar carry trade is unwound, we could well see a major downturn in global financial asset prices,' Mr Wong says. 'As US interest rates continue to rise, we believe it's just a matter of time before the trade will become too expensive to carry and positions will need to be unwound. This is probably the time, if not very close to it.' During the past two years the amount of dollars flowing into euros has ballooned from US$200 billion to more than US$400 billion. ABN Amro says the sheer size of the fund flows raises concerns about the consequences of a sudden reversal - especially when the Fed is on pace for a quarter-point rate increase every six weeks. Malaysia was a notable exception to the regional equity price weakness seen during the past two weeks, suggesting a trend in which funds are flowing into defensive markets - particularly those with high dividend yields and generally even-keeled stocks that can be expected to rise and fall more slowly than general markets. Regionally, the next best markets in which to shelter are Australia and Indonesia, as they combine lower volatility and above-average dividend yields, according to ABN Amro strategist Ben Rudd. He says the worst markets to be in are India and Korea, as expected yields are among the lowest in the region. Taiwan and Thailand rank among the highest yielding markets, each with a forecast yield of 4.7 per cent, but offer shares that generally rise and fall dramatically. Mr Rudd says his defensive strategy does not guarantee shares in safe-haven markets will not go down, but it is intended to guide investors towards companies that should provide shelter. 'We expect further weakness to hurt regional equity markets,' he says. The investment bank believes the dollar could rally over the coming months as investors sell down risky holdings and head into cash, but it maintains its negative outlook on the greenback over the next one to five years. If trouble arrives as forecast, several scenarios could play out in the US economy during the months ahead. The first is a sharp recession, most likely to occur early next year. The trigger point could be a US current account deficit of 7.5 per cent of GDP by the end of this year, if present trends continue. Another possibility is that the economy avoids a crash, but muddles along with mild growth of about half today's rate of 3.5 per cent. The limp economy will not be a recession technically, but it will feel a lot like the lacklustre period that spanned both the Reagan and Bush eras from 1985 to 1995. 'They can de-leverage and it can turn out to be either a very nasty recession, or a sustained period, something like a decade-long correction,' Mr Wong says. The slow-growth scenario will give time to work out the financial woes without extreme hardship, while slowly righting the economy for new growth. 'After 1995, after most structural financial problems had been resolved of deflated, the market started to follow a new trend rate of growth,' Mr Wong says. Any slow-growth scenario in America points to good times in Asia, as what unfolds should be similar to the boom that gripped the Asian Tiger economies in the mid-1980s. 'During that period, Asia entered into the golden age, a lot of money flowed in, domestic demand started to pick up, and asset prices increased very substantially. Eventually it grew into an asset bubble and led to the Asian crisis,' Mr Wong says. A catalyst could be a continuing flow of dollars to Asia. Last year the current-account deficit swelled to US$666 billion - a 64 per cent rise in two years, much of it facilitated by mortgage refinancing. The era of low mortgage rates, however, might be far from over. Analysts point out that US mortgage rates are set by the market-priced 10-year bond yield, which has largely ignored the Fed's rate increases. Mr Wong says he is reasonably confident the current downtrend caps the upswing in the US business cycle that began four years ago. Markets across the globe are exhibiting signs of the exuberance of market tops. 'What these asset classes are telling us is that investors in general have ignored risk,' he says. 'So at some point there will be a reduction in risk appetite or a reversion to risk-adverse strategy.'