2008 was a year that most equity investors would prefer to forget.  The problems associated with the global credit crunch accelerated during the fourth quarter of the year and the evidence for recession in most major economies became overwhelming.  Equity markets fell sharply during the first half of the final quarter but began to find something of a base towards the end of November.  Central banks continue to provide liquidity to markets although, while most commercial banks remained reluctant to lend to each other, there was some easing of liquidity constraints in the interbank markets towards the end of the period. 

The major feature in currency markets was the weakening of Sterling against all major currencies.  Against a background of falling interest rates, global investors feared that UK economy was poorly positioned to withstand a severe recession given its trade position and the large amount of outstanding consumer debt.  On a trade weighted basis, Sterling fell to levels not seen since the mid 1970’s.  It has been a long standing belief that Sterling had been substantially overvalued for a period of time and it is now possible that most of expected weakness in Sterling has now materialised.  However, it is still likely that UK interest rates could fall further from the year end level of 2% and this may precipitate some further weakness in the currency.

Industrial commodities tended to move lower against a background of falling global growth and, in particular, oil prices fell considerably further than most commentators’ expectations as speculative positions in the market continue to be unwound during the period.  In common with Sterling, it is possible that the majority of the fall in global oil prices has already been seen and that at around $40 some price support will materialise, particularly given the current instability in the Middle East and the uncertainty over gas supplies for UK and Europe from Russia.  The supply of many hard commodities is being cut back and although there are no immediate catalysts for a rapid bounce back in pricing power, when demand does eventually start to pick up through restocking it is likely that we will again see some upward movements in a range of commodity prices globally. 

Fixed interest markets continued to firm over the period given the anticipation of falling global interest rates and a perception of security offered by Sovereign government debt.  Global interest rates could again track lower throughout 2009.  Given the scale of the bail out of the financial system by major central banks, a substantial increase in bond issuance is inevitable and at some stage appetite of investors for these issues may begin to wane. However, we are retaining our more positive views towards conventional issues for the time being.  At some stage, however, we will be looking to revisit index linked stocks as a hedge against inflation. 

In the United States, consumer confidence continued to fall as even larger amounts of money were pumped into the economy by the Federal Reserve to maintain the integrity of the financial system.  The inauguration of President Obama this month, together with the introduction of new personnel and policies, could prove a catalyst for some short term recovery in the market, particularly as, nearly $4 trillion of investable funds are currently residing in money market funds with minimal levels of return. It is likely that the economy has been in recession since the spring and with interest rates likely to remain at a low level for the foreseeable future it remains our view that the US economy is likely to be one of the first major economies to show some signs of life.

The UK economy remains relatively poorly placed, in our view, given that residential property prices, a key determinant of consumer confidence, continue to fall in value.  Expectations are for UK interest rates to fall to 1% during 2009 and to remain at that level for some time.  This may not seem a particularly attractive backdrop for the UK equity market, but, given the sharp falls seen in the fourth quarter of 2008, a good deal of this recessionary news appears to be priced into the market.  It may be, therefore, that the markets will look to anticipate an upturn in the UK economy somewhat earlier than during previous cycles and for long term investors significant opportunities for investment may materialise during the early part of the year. 

In Euroland, the economic news from the major economies such as Germany and France is likely to improve in the near term whilst the peripheral economies, such as Portugal, Spain and Greece, are likely to see further rises in unemployment given the restrictive nature of the Euro.  The Euro itself may possibly come under pressure during 2009 as recessionary influences cause friction amongst a number of the participating economies. 

Globally, the newsflow from economic commentators is unlikely to get any better in the short term.  Indeed, there is a chance that the recession may prove deeper and more intractable than expected.  The global banking system continues to be under significant strain and a further recapitalisation of some major Western banks must remain a distinct possibility during the first half of 2009.  However, it does appear that a large amount of the deleverage of hedge funds globally has now been achieved, and, as has been noted, substantial investment funds remain on the sidelines in the form of cash deposits.  The fall in commodity prices and oil prices generally must also be seen as a positive for the western economies.  Should deflationary forces take a stronger grip on major economies, some additional action by central banks, such as the direct purchase of either fixed interest stock or equities may need to be considered.  Our view is, though, that any such deflation will be a temporary phenomenon and not as big an issue as has bedevilled the Japanese economy for the past ten years. 

In the light of such unprecedented economic conditions, it is difficult to be too dogmatic in forecasting the possible trend of markets for the near term.  It is likely that there may be some pick up in the level of merger and acquisition activity, which was at a particularly low ebb in 2008, as better financed companies seek to take the opportunity to grow their franchises at the expense of weaker brethren.  This may initially take place at the lower end of the market and some of the offers may be in the form of shares rather than cash, but, given the low valuations in this area there are undoubtedly good opportunities for this kind of activity to materialise.  We continue to focus on companies with a sound business model, good cash flow and solid balance sheets, as we believe that it will be in this area that investors will focus their attention once market conditions begin to improve.



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