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The Mena season

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We are at an important cross-roads for risk assets and we believe the next few weeks will be critical in deciding if bulls or bears have the upper hand and the next stage of the market’s cycle. There are many latent risks that are not being adequately discounted by investors in the prices of risky assets such as equities and commodities.

We recognise that QE2 has made a raft of speculative trades more attractive. It is important for us to be flexible to react to these movements, even if they may be unsustainable in the long term.

The Japanese market, one of our long-term overweights, was hit hard by the earthquake and tsunami. Much of what makes Japan an attractive investment in our eyes has been amply demonstrated in its people’s reaction to the horrifyingevents. The stoicism and quiet diligence of the rescue and containment effort have been remarkable and the value of civic responsibility, high building and engineering standards, as well as a world-class education system, have prevented this tragedy from assuming even greater proportions.

The market oversold the Japanese market in the days after but it has remained relatively sanguine about events unfolding in the Middle East and elsewhere. In recent years, investors have gradually eroded political risk discount on emerging markets. It is now becoming clear the lack of a democratic political structure makes social unrest – and economic disruption – all the more likely. With oil prices approaching a level which may pose a serious threat to the fragile recovery in the global economy, it could be the uprisings across the Mena region have implications well beyond what markets are accounting for.

Risk assets could also be harmed by the seemingly inevitable eventual default, or haircut, on peripheral European sovereign debt. Portugal has joined Greece and Ireland in receiving bailouts from Europe but the terms and the continuing aversion of financial markets to lending to these governments, may well mean it just delays default. Alongside this, central banks seem to be more hawkish as a result of global inflation fears and an interest rate rise would be seen as detrimental to risk assets, although it would probably damage corporate bonds more than equities.

Despite all these long-term concerns, investors seem content to persevere with risk assets. With some strong economic data coming out of the US and good corporate earnings combining with the risks outlined above, the direction that markets will take in the short term is unclear, although we side with the bears over the longer term.

Simon Mungall is head of multi-manager at Ignis Asset Management

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