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Cash crop from a small holding

Many pundits are betting on Europe as the best place to invest over the coming year. Europe undeniably has a lot to commend it, especially with current conditions in the US making a slowdown there – however soft – seem inevitable.

With a common currency and a high degree of job mobility, European companies have a wider range of human resources to tap into and a bigger market to sell to. Industrywide rationalisation leading to economies of scale and greater efficiency is another big plus in their favour.

The maturing population and the increasing adoption of an equity culture – a trend I expect will continue – have also been a positive force for European economies and stockmarkets.

Having said that, I would argue that the UK is where a lot of investors&#39 money should be – and not just British investors but people from America to Zanzibar.

Many investors, both here and abroad, have had a rollercoaster ride with their investments over the last year. The greatest volatility has been seen in technology stocks but other sectors, particularly telecom and media shares, have suffered serious setbacks too.

With the gyrations also experienced in exchange rates, particularly between the dollar and sterling, a concern facing many is whether current volatility will continue and whether it is even worth staying invested.

A good reason for recommending investments in UK companies is that avoiding exposure to the vagaries of the currency markets will eliminate one set of investment risks for those living or working in Britain.

The UK economy has performed well over the last few years, with growing international confidence and greater economic credibility since the Government made the Bank of England responsible for setting interest rates in 1997. That is certainly one reason why so much foreign investment has been pouring into Britain in the last few years, a trend which seems set to continue for some time to come.

These massive dollops of foreign investment are not just creating a nation of “burger flippers”, either, but are being used to build everything from microchip factories to state-of-the-art car plants.

Like many other economies, the UK is currently enjoying a period of low inflation. According to The Bank Credit Analyst, if we measure UK inflation using the harmonised price index (the method commonly used in most European countries), inflation would be as low as 0.7 per cent, not the currently quoted rate of 2.7 per cent.

This should enable the Bank of England&#39s monetary policy committee to cut interest rates aggressively – perhaps by as much as two or three percentage points should the UK economy begin to slow rapidly – which should be good for equities in general.

Coupled with this, the Government is likely to have a massive fiscal surplus this year which could enable it to cut taxes or increase public spending. This comes at a time when some of the previous fiscal stimuli announced in past Budgets will start to take effect.

One of the factors that has slowed world economies but perversely has been beneficial for the UK is the rise in oil prices over the last year. Recent oil price rises have brought in extra tax for the Government and helped stimulate 25,000 new jobs in Scotland with the North Sea oil reserves, according to recent Government statistics.

But which companies should one consider? While the idea of investing in the “best of British” may be a stirring theme, are the blue chips really a sensible option? A good case can be made for investing in some of Britain&#39s biggest companies, which arguably lead the world in their sectors. However, the reality is that unless you invest in only the very smallest companies, you will find that so-called British companies actually derive much of their income directly or indirectly from international trade.

Take, for example, Vodafone or BP. Both are world-class companies which have their origins in the UK but most of their income and trading activity takes place outside this country.

Any slowdown in the UK economy is likely to trigger substantial interest rate cuts, which should be beneficial for UK smaller companies, in particular. As many of the sectors already held by investors, such as telecoms, oils, pharmaceuticals and banks, are dominated by much bigger companies, simply holding smaller companies will, by default, help to diversify most portfolios.

It is often said that when the US sneezes, the UK gets the flu. However, given the UK&#39s ever closer links with Europe and the fact that European economies are three to five years behind the US, the UK should not be too badly affected by any slowdown in the US.

Given its size and still dominant influence on the world, one should not be complacent if the US economy suddenly went into recession.

However, Morgan Stanley Dean Witter has made the interesting observation that while UK trade with the US reached £26bn last year, the revenue of UK subsidiaries in the US was a huge £100bn. So, any slowdown in the US is more likely to affect big UK companies rather than smaller ones.

I would argue that, after several years when sterling has been relatively strong against foreign currencies, UK companies today are both lean and mean profit-making machines.

The dollar&#39s strength has already reversed and, with the euro&#39s original weakness now having turned the corner, it is getting easier for British companies to compete in new export markets in Europe and beyond.

Increased sales and exports, of course, have a disproportionately higher effect on smaller companies than on big ones.

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