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Year of two halves

This has been a very difficult year for investors, with a bear market, a financial crisis and now a global recession to contend with. Global stockmarkets have fallen by around 40 per cent since the start of the year.

Companies caught in the credit storm became lightning rods, channelling the whole force of the market’s anxiety, but no single company’s story provides insight into the period as a whole.

Viewing the year through global growth and inflation indicators provides a more useful perspective. Inflation was the problem in the first half of the year and economic weakness in the second.

As the year began, US interest rate cuts and currency weakness acted as a powerful stimulus for China and other resource-hungry emerging market economies pegging their currencies to the dollar.

Commodity prices surged but with developed economies slowing, the world economy as a whole was in stagflation. Central banks faced a conflict of interests between financial stability and price stability. Commodities, bonds and cash were the best assets to own while equities were weaker.

July was the turning point. Global demand slowed, followed by demand for commodities. Prices collapsed and inflationary pressures evaporated, especially when a seizure in credit markets led to a further lurch downwards in global growth. Coordinated and aggressive interest rate cuts followed, along with liquidity provision, recapitalisation and multi-billion-dollar stimulus packages, all in a bid to lessen the severity of the overspill from the financial crisis.

Economic data now points to a period of reflation, characterised by continued economic weakness but with inflation falling. This backdrop favours government bonds and interest rate-sensitive stocks, particularly financials, property and the consumer sector. Reflation is likely to continue well into next year. With the financial crisis passing into the real economy, 2009 will be a dog fight between weak activity and government efforts to reignite growth.

Commodity prices are likely to remain under downward pressure as industrial activity contracts. Developed markets will outperform emerging markets. The US market looks likely to benefit from diversity and a heavy exposure to the defensive consumer staples and healthcare industries.

There is cause for hope. At some point, a new recovery will start. However, for me to become bullish, I will need to see signs that policy easing is working, banks are lending again and bargain hunters are returning to property markets.

Bear market rallies will be difficult to time, so a balanced portfolio will offer some protection from the extremes of volatility. Caution and diversification will be the watchwords in 2009. With sentiment this depressed, we should not be asking what could go wrong, we should be asking what could go right.

Trevor Greetham is manager of the Fidelity International multi-asset strategic fund

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