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The new world disorder

Falling prices do not mean that advisers should tear up their sales script.

Investors and their advisers today find themselves in unfamiliar territory. Current economic and financial news seems to be following a rather different script to the one most of us wrote just a few months ago.

In past weeks, we have seen Government intervention to curb excessive movements both in the oil market and in the currency markets. Economically, we have seen a fairly steady stream of weaker reports from Europe but strength in the US.

When most expected str onger numbers, it was the Eurozone that showed five successive mon ths of slowing manufacturing while in the US strong services and employment growth still indicate a distinctly hot economy.

To confuse the picture still further, the consensus on strong corporate profits was shattered by six successive US companies – representing more than 20 per cent of the capitalisation of the Dow Jones – warning on profits in quick succession. Some bla med the euro for higher input costs, others were simply “marooned” bet ween the new and old economies (Xerox, Kodak, Apple). But it was Dell and Intel that shocked analysts and investors and triggered a 16 per cent fall in Nasdaq in just one month.

Institutional investors res ponded as they normally do in turbulent times – by doing pretty well nothing either on the buy or the sell side. Without their steady momentum, buying markets drifted steadily lower.

Taken together, rising real interest rates, extreme currency movements and a sudden transfer of resources to the Opec oil-producing countries could arguably give a fairly classic backdrop for an equity bear market.

Or do they? Certainly, oil and interest rates will slow global growth but the IMF estimates still suggest that the world economy will grow by well in excess of 4 per cent this year with no material worsening of inflation. The impact of expensive energy will be modest compared with previous oil crises.

Indeed, the real impact on today&#39s competitive global economy is probably more deflationary than inflationary.

This is because we expect consumers to react to the effective “oil tax” not by dem anding higher wages but by pressing for cheaper goods and services.

You can see this already in the low core inflation in Eur ope and the US and even in an event like the hauliers&#39 blockades across Europe.

These reflected not just high oil prices but the inability to recoup them through higher trucking rates or farm prices to consumers. In other words, the traditional link between oil and headline inflation appears to have been broken in today&#39s competitive economy.

For investors and their independent financial advisers, this has important effects.

In the short term, it means that higher real interest rates and fears of oil-induced inflation will keep liquidity tight and markets weak.

But within a few months it will be clear to central bank ers and investors alike that there is no real inflation threat and this means they can consider cutting rates far sooner than most expect.

This will result in suitably beneficial effects for the world economy – a soft landing – and for financial markets – a strong liquiditydriven bounce.

So, in explaining to clients what stockmarkets are doing to their investments, we do not need to tear up a script that has worked well for inv estors and their advisers.

We do, though, need to amend the script a little – particularly to explain the divergence between today&#39s short-term turbulence and tomorrow&#39s likely resumption of encouraging equity returns. This scenario relies on many factors but among the most important is a stable dollar.

This is why we at Sarasin have always found the almost hysterical concern in the financial press about the level of the European currency rather confusing.

After all, a weak euro ass ists the European recovery and softens otherwise painful corporate restructuring prog rammes. But, more important, a strong dollar allows the US economy to function at relatively high growth rates without triggering imp orted inflation.

In Europe, we are happy that a weak euro, tax cuts and looser fiscal policy coupled with strong technology investment (post-UMTS auctions) will sustain growth at between 3 and 3.5 per cent despite higher oil prices.

In Japan, strong IT dem and another supplementary budget and improving consumer confidence are encouraging signs.

The risk lies more in the emerging world, which is still vulnerable to high energy prices and rising real interest rates, with growth in Korea and India probably the most at risk.

Meanwhile, despite recent profit warnings, we are convinced that technology investment will remain robust although priorities are changing. Many of the recent problems have been in companies that have simply botched their transition from old to new economy – Xerox, Kodak – or else in those specifically exposed to the low-margin currency-sensitive PC market – Apple, Intel.

That PC demand in particular should be softening sho uld come as little surprise. Curr ent user emphasis is on internet transmission speed and not internal processing/memory capacity.

But in its place will be capital expenditure dedicated to 3G mobile, broadband access, e-commerce applications and consumer electronics. In the latter, Playstation2, Blue-tooth-enabled products, flat screens and smart set-top boxes are just a few of the possible killer products.

Despite a few turbulent weeks, there remain more than enough investment opp ortunities for a forward looking portfolio manager or IFA.

With a global perspective, a theme approach and suitable risk control via currency or bond holdings, the next 12 months can generate strong equity returns – the bulk of them now in areas of the old economy that are successfully transferring their skills to the new economy.


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