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Mixed response

Present conditions point to a blend of capital preservation and some investment in faster-growing markets

Few will mourn the passing of 2011. There were precious few ways of making money as an investor and plenty of ways to lose it.

As the year advanced, the euro crisis became all-consuming. Many of us expected it. We had sold or avoided all euro assets, expecting recession, falling bond prices and general banking disruption. We were not disappointed.

There were a couple of surprises during the year. We, along with many others, thought UK gilts, on very low yields by historic standards, would not produce a decent return. We worried lest the likely downgrading of the borrowing figures, which duly occurred in the autumn statement, would drive bond prices lower and yields higher.

Instead, the Bank of England announced yet more quantitative easing while global investors regarded UK bonds as a suitable refuge. The year ended with gilt yields even lower than in January 2011. The emerging markets, which did not disappoint with growth in output and profits, did not generate the better stockmarket performance we hoped for. They fell in the second part of the year as Europe declined.

We took our discretionary portfolios much more liquid in 2011 to shelter clients from the collapse in share values.

What do we expect for 2012? The year is likely to begin with more of the same. The euro crisis is far from resolved. We should expect more crisis meetings, more failures to reach a comprehensive agreement that satisfies the markets and more pressure on weaker sovereign debts.

The French and the Germans do not really agree and the French elections will add to the bumps in the ride. We are not committing cash to these treacherous markets.

However, we do think shares in the better emerging market economies are very cheap. We have been adding to our positions in China to take advantage of very low ratings, where funds were light by our standards. Asia and Latin America generally should have another decent year of growth next year, which at some point should drive valuations of shares upwards.

It is true these economies will not have such easy times exporting to the EU, as European economies slow or decline further. However, the rising numbers of people in emerging countries who have money to spend means more domestic demand growth. The US should also continue to move ahead in the presidential election year. The politicians there are not about to agree a further major austerity package while the Fed is unlikely to rock the boat too much with elections pending.

Could the weakness of the EU banks bring everything down? We do not think so. Recent actions show that the European Central Bank has more scope to protect and finance the banks than it does the weak countries. We expect them to muddle through with the banks.

The countries are more difficult. The two most likely scenarios are the weakest countries dropping out of the euro to save the rest or planned and controlled defaults by weak countries as they struggle to cut their debts and deficits.

We suggest a mixture of capital preservation and some investment in the fastergrowing areas of the world. The bull case for emerging economy shares and commodities remains strong. Indeed, it has just got stronger because emerging country shares have fallen in sympathy with the EU for no good reason.

For anyone prepared to take some risk and seeking a good longer-term real return, now must be a good time to be buying these assets.

It is depressing to see how US, UK and general European shares have once again ended a year and a 10-year period, when they have not delivered positive real returns. With the debt overhang, weak banks, spending cuts and slow or no growth to come, it is difficult to see why this is about to change unless you are a very lucky or talented shorter-term trader.

John Redwood is chairman of the investment committee at Evercore Pan Asset

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