Interest rates moved higher in both the UK and Euroland during the first quarter of 2007 whilst rates in the United States remained unchanged.  We reiterate our view that interest rates will stay at the current level in the United States for the near term but that in both the UK and Euroland rates will move a little higher over the next quarter.  Data on economic growth from both the UK and, in particular, Germany have been strong over the past month or so but in the case of the UK we feel that a further quarter point rise in UK rates may well mark the peak of the current cycle.  The Federal Reserve, on the other hand, has sent out messages indicating that it is still concerned about inflation but that it does have the overall position of the housing market to consider when assessing its attitudes towards interest rates.

Currency markets have been more volatile than in the past few quarters and the euro has started to strengthen against sterling.  We anticipate that this trend will continue throughout the rest of 2007.  On a purchasing power parity basis, sterling is somewhat overvalued against most major currencies and we continue to anticipate a gradual depreciation of the pound against a basket of leading currencies over the medium to long term.

Global oil prices trended upwards during the first quarter of 2007 and, with the increased international tension in the Middle East over the past few weeks, we suspect that further rises may well be in prospect, although historically the second quarter tends to be somewhat weaker for oil prices, given warmer weather in developed economies and a fall in gasoline demand ahead of the holiday season.  Base metal prices have also been volatile recently but we firmly believe that we are still in a ‘super cycle’ for many industrial metals, with continuing strong demand coming from China and the Pacific Rim economies.  Price increases of the scale seen over the past few years, however, may not be seen in the short term.

Bond markets have experienced a poor quarter as rising interest rates and the renewed threat of inflation in the industrialised economies have affected investor sentiment.  We have consistently maintained that bond markets have been poor value for the past several years and continue to advocate this stance.  Inflationary pressures worldwide seem unwilling to abate and, against this background, it is hard to see fixed interest markets generally making much progress in the short term.

Turning to Global Markets, the economic news from Japan has been a little mixed of late: the most recent Tankan economic survey indicated a unexpected fall in business confidence in the heavier manufacturing end of the market.  Somewhat unreal expectations for real estate prices have also been apparent and these pressures may well subside somewhat.  Overall, Japanese markets may struggle to make much fundamental progress over the second quarter although we do regard longer-term prospects for this particular equity market to be promising.  Growth rates in the Pacific Rim economies of Taiwan, Singapore, Hong Kong and Korea again remain robust and valuations for these equity markets remain relatively undemanding.  We continue to see good prospects for this area during the rest of 2007, provided that global oil prices do not again reach the $78 level seen during the middle of 2006. 

The American economy has been mired in adverse news flow concerning more general problems in the housing market.  More than thirty providers of so called ‘sub-prime’ mortgages have been forced to seek protection from their creditors and across many parts of America housing inventories are building up and prices of cleared stock falling.  The Federal Reserve, as yet, is continuing to make relatively soothing noises and playing down the importance of this particular issue for the markets and the impact on overall levels of consumer confidence, which a deepening of housing price woes may elicit, cannot be readily quantified.  We continue to take a very close interest in developments in this area of the American economy, given its potential to destabilise global consumer confidence.  In addition, some recent evidence suggests that all is not well in both the French and Spanish property markets at the moment, where the general levels of overbuilding and consumer overconfidence have been evident over the past couple of years. 

Turning to equity markets, we again reiterate our preference for equities as our asset class of choice during 2007.  We expect that overall returns will outperform those coming from fixed interest markets and cash.  Globally, many companies are continuing to enact substantial programmes of stock repurchase and it is noticeable that levels of merger and acquisition activity continue at a relatively high level.  We do not envisage any slackening in this level of activity, and indeed with the recent developments at companies such as Boots, Taylor Woodrow and Sainsbury’s it is indeed possible that further household names in the UK equity market may succumb to such attention as the months progress.  In Euroland, the German economic revival continues to progress but our enthusiasm for the Italian economy remains rather muted whilst in France the overall economic situation is somewhat clouded by the current presidential election campaign.  The overall strains within the Eurobloc may well become more apparent and could well be exacerbated by the gentle rise in interest rates which we expect 2007.

Turning to our investment themes, we have made few changes recently and overall our asset allocation approach continues to be orientated towards equities and away from fixed interest.  Within the equity arena, we retain our enthusiasm for companies involved in the sourcing and supply of luxury goods and have also recently been researching more companies involved in the supply and manufacture of security products.  Real Estate, which has been one of our major themes over the past three years, is now approaching a degree of maturity within the UK although good opportunities for rental growth remain on the continent.  It is now probable that we will look to rein in some of our exposure towards real estate companies in the UK during 2007 as valuations are becoming somewhat more aggressive.

It has been a volatile quarter for most asset classes and the negative sentiment concerning the American housing market and the Middle East will no doubt continue throughout the rest of the year.  However, investors appear relatively sanguine at the moment and valuations overall in equity markets are not particularly demanding for this stage in the cycle.  Acquisition activity within equity markets remains at a high level and this is expected to continue, as we expect will the process of ‘de-equitisation’, by which companies repurchase their own stock in capital markets.  We look forward with some confidence towards the prospects for markets in 2007, although we are mindful of the political and economic headwinds that we have mentioned as possible counterbalancing influences.



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