Welcome to 2004 - Economic Commentary
George Bush Jnr and his re-election As we move towards the Presidential Election at the end of 2004, many unpleasant issues will have to be resolved. Terrorism etc
2004 Boring and Dull? Financing of the US debt by Asian economies buying and owning over 55% of the US Treasury market, in an attempt to stem the appreciation of their own currencies, can only continue for so long before something has to break; and as long as US
interest rates remain low there is little incentive for foreign governments to buy dollars in this way. The effect of massive tax cuts and givebacks in America will slowly unwind in the UK. Gordon Brown is into a massive borrowing spree to
maintain public expenditure, ultimately, in both cases, it has to be paid for by someone, somewhere. Taxes could go up but this of course will dampen economic growth. Interest rates could go up and this will clearly dampen economic
performance. At some point there is bound to be the re-emergence of inflation, but again, how far can this go before the reality of global deflationary forces sets in, particularly driven by the massive shift of manufacturing jobs to Asian
economies and the general low inflation, low interest era in which we live? The Investment Model Going Forward – is more of the same For lower risk investors we would consider a combination of: equity Income funds in the UK; a
reasonable amount of corporate bond funds with an emphasis on funds which can invest across the yield spectrum; a modest exposure to commercial property, and; only a small proportion in higher risk but potentially lucrative markets including
the Far East, in particular China, and in global natural resources funds. Depending upon your timescale, the amount of income required and your risk profile, a higher exposure to the Far East could prove profitable in the long run, in
particular the double play of buying Dollar-denominated assets in China, where you may see a currency gain in addition to the growth potential of such a populous and (relatively) emerging economy. Combining this approach with investment in
natural resource funds, as the East tools up to build their own economies in the image of Western industrial giants, is creating enormous demand for commodities worldwide and could prove to be very rewarding (though naturally volatile and
therefore higher risk). Finally a modest exposure to index linked stock should be considered as a low-risk hedge against what seems to be a modest but inevitable rise in inflation, as Western economies try to devalue their debt mountains.
This, of course, will very much depend upon how Asian governments, in particular China, decide how to play their hand in relation to their currency value. Conclusion
Many of you will recall, after George Bush Jnr won the Election three years ago, we observed that extraordinary and coincidental global events often
occurred after Presidential Elections with extremely narrow majorities (possibly negative in the case of George Bush Jnr), including such notables as Kennedy. With '9/11', the Iraq War, a massive US budget deficit and an extraordinary global
overview from the other side of the pond, George Bush Jnr has lived up to the history of narrow majorities.
Clearly there is still the threat of massive global d-estabilisation by biological or other unpleasant event. To a certain extent these have been factored into the market, such that there may not be quite the same volatility – the
bombings in Turkey revealed little negative market reaction - but it just depends what happens and how it happens. The following comments presume management of the status quo from a terrorism perspective.
In
our opinion much of the growth of the Equity Markets around the world in 2003 has already taken into account expectations of future corporate earnings growth, in addition to taking up some sentiment-driven slack in the markets following the
completion of the first phase of the war in Iraq. However, in a low Inflation, low interest-rate era the former may prove difficult to justify, such that equity markets are likely to dribble sideways for some time, despite short-term ups and
downs. US equities become more and more expensive because of the dramatic slide in the value of the dollar, which will probably continue for some months, over and above the questionable valuations of large portions of US equity market indices.
To our mind 2004 will not provide a spectacular investment return
for most balanced, diversified portfolios, despite the emergence of one or two possible 'hotspots'. We think there is unlikely to be a dramatic collapse in equity values or in property prices, but we expect it will continue to be difficult to
make investment returns in excess of 5%. Investors in developed Western economies should become accustomed to this reality.
Patrick McIntosh FLIA (by Diploma) ASFA
KMG Financial Limited
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