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Review of 2007 and what lies ahead
Economic Snapshot
What a difference a year makes! With strong global growth and rising commodity prices at the start of the year turning into concerns about the US sub prime market that started in the summer, the world economic outlook is very different now.
One of the most important effects of the restricted credit created by the US sub prime issue is consumer confidence. The strong relationship between consumer confidence and property prices can mean any bad news about the housing market is sure to dampen consumer spending which, in turn, could affect business confidence.
Another key driver for economies is inflation. The continued unquenching demand from China and Asia as a whole for energy and commodities could result in economic growth and corporate earnings being reduced by the effects of inflation. Some have commented that China will begin to dictate how bumpy a ride Western economies will have.
Effect on sectors
Debt, consumer spending and corporate profits have all supported strong equity markets in recent years. However with these factors not as strong as in recent times, uncertainty surrounding the end of 2007 and beginning of 2008 has grown.
Traditional investment fundamentals will be central to discovering the right stocks in 2008. This, in part, has led the investment managers to move away in the UK from small- and mid-caps, which have led the way since 2000, to large-caps. This is reflected in part by the perceived stability in large company shares in terms of strong cash flow, solid balance sheets and attractive risk/return profiles and the greater dependence of small- and mid-caps on ready credit. In addition it also likely to stem from investor nervousness over the valuations of small- and mid-cap issues, which had reached high levels by historical standards.
The one exception in the large cap story is likely to be banks with many believing the aftershocks of the credit crunch will continue to affect those banks that are heavily reliant on mortgage business.
Many companies in Asia have displayed the strong investment fundamentals mentioned. With their growth not being down to debt there continues to be strong platform for continued growth whilst the rest of the world suffers from the aftermath of too much borrowing.
The Property sector has been one of the hardest hit in 2007 and will continue to be at risk to a US led recession. Any slowdown brings inevitable downside risk to the earnings of property companies. Lower rental growth, potentially lower levels of occupancy, increased downtime and increased incentives to release properties, as well as slowing any development pipeline rollout, would all start to chip away at company profits. We believe, however, that some funds are now oversold and there is a bargain for the canny investor.
Summer 2007 also marked a significant re-pricing of risk in global fixed income markets. Again, as with UK Equities, the US sub-prime market and its relationship with structured debt products lead a flight to quality, in particular into government bonds. Whilst economies will slow and the evolving US housing problems and tighter credit conditions have an impact on bond markets, the yields already seem to factor in a lot of potential bad news so the fixed income asset class should still offer investors some attractive opportunities in the coming year. We certainly think so.
Conclusion
The increased market volatility, which has been in evidence since summer 2007 is likely to continue. Volatility is not necessarily a bad thing as it often helps to highlight the quality of some investments and indicates the importance of diversification. The volatility experienced already has shown the inverted relationship between equities and fixed income, government bonds especially. Property and commodity markets have also shown their own, particular investment traits. Investors should be considering the traditional means of diversification – by asset class and by geography, linked firmly to your own tolerance for risk and your future needs.
As always, we are here for you – just call or e-mail.
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