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Positive forces

Those who look on the bright side will find much to be cheerful about in 2007.

As we move into 2007, it is appropriate to consider the current economic climate and the outlook for markets. It is good if we are able to adopt a positive tone.

This is in marked contrast to those in financial services who constantly gripe over one thing or another, whether it be principles-based regulation, procedures, compliance, EU directives, rising interest rates or the US economic problems which are said to signal the end of a strong run.

UK equity markets have performed exceptionally well for four consecutive years, with the FTSE All Share index increasing by 20 per cent in 2003, 13 per cent in 2004, 22 per cent in 2005 and 17 per cent in 2006. Given this situation, many suggest that 2007 will bring a correction or a more stagnant environment for equities.

There are, however, more reasons to be cheerful. These include that fact that if you take into account the falls in the market which pre-dated the above statistics, there has been no real rise in markets over seven years.

Despite the surprise but modest interest rate rise, there is a stable environment for inflation and interest rates. (I really do not know why this was such a surprise. The talk has been of rates rising for some time and, in my view, it was the timing of the decision rather than the decision itself which was the surprise).

There is a growing labour market and, despite increasing levels of consumer debt, the ratio of domestic assets to liabilities remains broadly constant over the last 10 years.

UK pension fund deficits are reducing. Business investment is increasing and should counter any reduction in consumer spending while cashflow yields are increasing.

The continuation of merger and acquisition activity and share buybacks is positive and, with price/earnings ratios reducing for seven consecutive years, a rerating of the FTSE All Share is overdue.

Shocks and volatility are virtually guaranteed but I would suggest that these represent buying opportunities, just as they did in 2006 with the market deriving most net returns in the second half of the year after the May sell-off.

On the negative side, the US may cause problems but a soft landing seems the most likely outcome and this should be positive for global markets. In the UK, inflation may be a concern but, provided it operates somewhere in the region of 2 to 4 per cent a year, this tends to be positive for UK equities.

As for other sectors, there are fewer reasons to be quite so optimistic about UK commercial property and it may be time to take profits in this sector. If investors must invest in property, I would favour the newly launched global property funds on the understanding that these have some correlation to global equities as well as global property prices.

The UK mid-cap sector has also delivered excellent returns and profit-taking here would be sensible, given that although a downturn is unlikely, it would affect the mid-cap market more than any other because it has been boosted by geared private equity which needs a strong economy to continue to deliver profits to cover the debt.

Commodity prices continue to be volatile and any investment in this sector should be well diversified and preferably protected by a structured product.

Bonds have delivered relatively poor returns in very recent years. If the economy continues to be benign, high-yield bonds look the most attractive. Gilts and investment-grade corporate bonds appear very dull in comparison.

It is still the case that, net of charges, certain high-interest cash accounts can look far more attractive than gilts or even some corporate bond funds, particularly in view of the certainty of returns available in the former.

The smart money is currently buying into the UK equity market. The consumer should note this and follow suit.

Peter Heckingbottom is deputy managing director and investment director at Pearson Jones.

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