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Diversify with quality balance

Making financial predictions is always fraught with problems. The tendency is to forecast forward what we see in markets today.

Markets never stand still and many influences we are unaware of today cause market commentators to look fools months and sometimes days later.

The terrorist attack in America is one such example, an event risk that must be a billion to one. It will have thrown out of kilter all those previous economic and market forecasts, even if they happen to be right. So what we all want to know is – what are the implications of the crisis we have seen?

Perhaps the most truthful answer is no one can really tell. But what we do know is that the US was already on the brink of recession before the events of last week. Remember, the American definition of a recession is two consecutive quarters of no growth. Clearly, the few days with financial markets closed and air travel all but grounded have nothing but negative growth implications.

Going forward, the tourism and leisure industries world-wide are likely to suffer as US citizens, in particular, curtail travel. Past terrorist action in London has shown how quickly Americans can react to perceived dangers.

Airline shares worldwide have already reacted, with British Airways down by 34 per cent last week. Given that some have more precarious balance sheets, the possibility of bankruptcies must be high.

Other sectors which will be hit must be insurance and consumer retail. The latter already looks fully priced, at least in the UK, and must be vulnerable to any slowdown.

Sectors that are likely to profit are defence, which is likely to show increases in spending, and specialised IT companies that deal with security and back-up systems.

I would be wary of traditional safe havens such as gold. We have seen many crises in the past with the price of gold moving up a little and then going back down.

Oil might be another beneficiary if there were problems with supply. But in this crisis, oil supplies do not, so far, appear threatened. In addition,a slowdown in the world economy is more likely to cause the price of oil to fall as demand weakens.

Against all this potential bad news we have already seen action from the Federal Reserve and the European Central Bank to lower inter-est rates and the Bank of England could follow.

Some analysts had forecast the bottom of interest rates in the UK but I would suggest that they are likely to fall to at least 4.5 per cent by the end of this year. Rates in both America and Europe will drop by at least another 1 per cent.

This should benefit the equity markets but more obviously the short end of the gilt market and investment-grade corporate bonds. However, a recovery in the high-yield corporate bond market is likely to be postponed until the economic picture is clearer.

This suggests that clients, if they have not already done so, should have well balanced portfolios with good diversification across all world equity markets and exposure to fixed interest. It does not suggest a panic sale.

Previous world crises, I would argue, have actually provided buying opportunities, although it never feels like it at the time.

Quality UK funds should be sought such as HSBC growth and income, Credit Suisse income and Liontrust first large cap.

With the top building soc-iety accounts at present only giving around 5.6 per cent gross and likely to fall further, equity income funds with yields approaching 4 per cent plus must surely start to regain their popularity.

These funds have been completely overlooked in the growth mania of the last two or three years yet provide exactly what most clients want – a rising income with potential for capital appreciation.

For those seeking a “one fund to fit all” situation then a quality international investment trust such as Foreign & Colonial fits the bill, with 35 per cent exposure to the UK and the rest overseas.

The most important part of the job is to hold the hand of clients and remind them that these are long-term investments. Jumping in and out of the equity markets is usually highly unprofitable.

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