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Investment view

I hate this time of year. It is not just that it is cold, generally overcast and the are roads treacherous as often as not but we are also expected to polish our crystal balls and gaze into the future. This is never an easy task. Trying to predict the outcome for 2002 will be particularly hazardous.

Reading through some recent comment in the financial pages, I was struck by the absence of forecasters predicting a US recession for 2001.

A year ago, the US economy was slowing rapidly, new economy stocks were in turmoil and we had just finished the first down-year in markets for some time. Even so, concerns over the US economy were relatively muted. Most believed that America would avoid moving into negative territory. Indeed, it was not until January 2001 that the Federal Reserve Bank started cutting interest rates – a programme that took on an even greater significance in the aftermath of September 11.

The market was telling us by midsummer that all was not well in the American economy, yet it took the terrorist attacks to focus attention on what was happening in the economy. The short, sharp shock this administered was enough to move the US into recession, although subsequent revisions to GDP figures showed an already dire situation had developed as early as the second quarter. It is clear that you could not blame the recession on September&#39s events, so it seems that last year&#39s pundits were well and truly caught out.

Today, the broad consensus seems to be that 2002 will be the year of recovery – both economically and for markets. Still, the signs are more confusing than usual. In the US, the recession will probably have extended for a full nine months once we know the outcome of the fourth quarter 2001. Nor is anyone confident that the first quarter of this year will be any better. Job losses have been mounting. Sluggish stockmarkets have damaged the wealth of Middle America. Consumers are cautious. Indeed, it is remarkable that the diminution of personal wealth did not result in greater retrenchment by US consumers and investors. Still, you must hand it to them. They are a confident nation.

Here, we seem to be doing rather better than either America or Europe – economically speaking – yet our stockmarket was among the poorer performers of 2001. This may be because we are paying the price for having been ahead of the game.

Last year saw much publicity given to pension funds moving away from their equity bias – an approach that had stood them in good stead for several decades. But the price these funds were paying following two years of equity under-performance was that matching expected benefits was becoming more difficult. While this problem can be solved in part by transferring risk to the pensioner through restricting defined benefit schemes, this in turn creates pressures for a Government determined to see a higher level of personal savings so that its own liabilities can be reduced. In theory, this should be good for equities. There is little sign of a beneficial effect so far.

Still, my money is backing an outperformance of equities over bonds for the current year, based as much on a belief that a third year of superior returns in the bond market seems unlikely as anything.

Moreover, it must be long odds on three years of negative equity returns. Aside from anything else, such a scenario could have long term damaging effects upon investor psychology, so interested parties – which include Governments – would work hard to ensure it does not happen. That is the theory anyway. In practice, investors may be becoming more risk averse as they come to terms with ever-present volatility and a market that punishes mistakes swiftly and severely.

As for which markets might deliver the best returns, the wild card is Europe, where the change over to euro notes and coinage could bring the much needed boost this currency deserves. For the safety conscious our own market does not look too demanding on valuation grounds and provides as international an investment opportunity as any. But in the end it will be the health of the US economy and of its stockmarket that will be of most concern in the months ahead. We should continue to cast our eyes to the West. From thence cometh our salvation.


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