The issues that have concentrated our minds and investment strategy as we head into the autumn period are summarised below. The whole credit crisis and economic dilemma is driven, in my opinion, by:

• The demographic age wave
• population explosion
• the creation of illusory returns to generate income for the elderly whilst also supporting unrealistic wealth for a less productive Western economy and a burgeoning emerging economy.

The key issues that concern us in the very short-term are:

• growing levels of public debt
• growing levels of unemployment
• massive increases in taxation to pay back the debt that has been transferred from banks to governments in Western economies
• lack of credit in the system
• falling consumer confidence
• a decoupling of Western economies and emerging economies, albeit gently.

There is of course massive evidence throughout history that the world and its population have been through similar economic and financial crises to the one that besets us at this time. Be it the collapse of the French aristocracy and royal family leading to revolution, the arrival of the Second World War or numerous previous and subsequent crises, all are driven by fear, greed, and stupidity.

There is however a possible factor that is not fully understood in this particular crisis.

G20 holds it together

We have been observing for some time that so long as the key central bankers of the world and their finance ministers remain co-ordinated, then markets will find it very difficult to divide and conquer or extrapolate profit from weakness by playing one currency or country or even continent against another.

If they can maintain a common approach and continue to pump the world with liquidity, could we trade through and out of this economic crisis? Many believe that the result of printing money must be inflationary, but there are also many counter-arguments to this position including:

• high levels of spare capacity in a global economy
• high levels of unemployment will continue to increase, leading to moderate wage settlements
• continued globalisation and development of production efficiency around the world and from emerging markets.

Could we therefore maintain some form of "Goldilocks environment" whereby growth trends return to above normal while inflation remains under control? If per chance China returns to an 8%-10% growth rate; if Europe and America can organise and develop growth rates of 4% or more; if emerging markets can also develop and grow at significant rates of return, will the global economy expand sufficiently quickly for the following to occur?

• unemployment gently reduces, leading to lower expenditure by Western governments
• public spending is curtailed. (On this point, from the Alastair Darling/Callaghan lecture and other public pronouncements this government appears to be heading in opposite directions at the same time, i.e. promising that we can spend our way out of recession and yet observing that they are going to cut public spending)
• corporate profits return leading to better tax revenues for Western economies
• public spending returns to normal leading to higher tax revenues from indirect taxation and productivity as a consequence of supply and demand
• reasonable wage settlements and marginal increases in Income Tax from an increasingly (and reasonably) wealthy population with improving incomes
• continued low levels of interest because inflation remains subdued as a consequence of the above observations, leading to more disposable income for consumers and investment in infrastructure by companies and governments.

Indeed, if interest rates remain at 0.5% debt as a percentage of GDP could be 100% but still reasonable to manage if the economy is performing well.

Goldilocks

If therefore the Goldilocks scenario as detailed above can somehow be managed by the G20 central bankers and their respective governments, and if they all recognise the need to work together to achieve this common goal and aim, then of course there is a distinct possibility that we could trade through and out of this massive economic crisis.

In the meantime however, we suspect that the same G20 central bankers and governments will bear down on bankers and on debt, and will try to do all they can to eliminate the probability of a further property bubble or any other bubbles (if they are successful as detailed above).

If people in the western world can be convinced that their house is not their bank account and that lending restrictions imposed are adhered to aggressively, then we may well maintain equilibrium and gently manage away the crisis without creating another property price bubble.

KMG's investment strategy

We have taken on board the above points and re-examined our investment strategy. We continue to believe that the five equity themes of infrastructure, emerging markets, natural resources and global basics, together with large capitalised stocks and energy is most likely to succeed and benefit from the above paradigm. In the fixed interest portfolio we believe that our strategy (particularly in convertible bonds, absolute return funds, as well as corporate debt, whilst reducing exposure to sovereign debt and gilts) most practically fits the argument.

This is particularly relevant because we still err in favour of fixed interest funds over equity; and we are somewhat sceptical about the G20 ministers' and central bankers' ability to achieve the Goldilocks scenario.

We continue to work on the basis that we are likely to see a further setback in share prices or anaemic economic performance in the foreseeable future.

September 2009, Patrick Mcintosh