The investment outlook for 2008

Myra Butterworth looks into her crystal ball to see which way markets are likely to go and identifies the winning themes for investors in 2008, with an eye on climate change and emerging markets.

Investors have been left shaken by the stockmarket volatility of recent months, but the New Year brings hope of a fresh start and the prospect of some more steady returns.

Several factors have contributed to the volatility we've seen, including the weakness of the dollar and the soaring price of oil. But it was concerns about sub-prime mortgage lending in the US and the global credit crunch that ensnared Northern Rock that shook UK financial markets over the summer and led to the stockmarket tumbling.

When news of Northern Rock's initial loan from the Bank of England emerged, queues of panicking Northern Rock customers were seen withdrawing their money amid fears for the bank's future. At one point, the company's phone lines were jammed, its website crashed and all 72 branches were besieged by thousands of customers worried they might lose their life savings.

With so much financial turmoil in the markets spilling over into the high street in this manner, it would not be surprising to find investors hiding in a dark corner, fearful of what 2008 may bring.

Experts have already expressed fears about the US and UK slipping into recession in the coming months - as the old adage points out, 'when the US sneezes, the rest of the world catches a cold'.

"My main concern is the US housing market," says Jim Leaviss, head of retail fixed income at M&G. "There is a record over-supply of houses on the market, sales of houses are falling and house prices are plummeting. Historically, this situation has always resulted in or coincided with an economic recession." Leaviss rejects suggestions that if the US slips into recession the rest of the world will prop up the global economy.

"It is true that the world is less reliant on the US today than it has been over the past few decades. But there is little doubt that the US slowdown is likely to have a significant effect on the global economy - China is the world's workshop and is growing at more than 11% a year, but if US consumers stop buying, then the world's workshop will stop making."

Reasons to be cheerful

More optimistically, some commentators believe 2008 could turn out to be far more promising for investors. Alan Steel, of independent financial advisers Alan Steel Asset Management, bases this positive prediction on trends in the US stockmarket since 1900. This trend is reinforced by an examination of the four-year US Presidential cycle. "This year [2008] is a US election year. Stockmarkets do well in US election years," Steel points out.

Similarly, Philip Pearson, of IFA P&P Invest, advises against getting drawn into the tide of doom-and-gloom scenarios. "Falling stockmarkets and bad financial news create short-term pessimism, with most investors steering away from shares and seeking out safe havens for their capital," says Pearson. "But it's worth remembering that if you want to make money, don't follow the crowd."

He adds that the UK market offers good value, the secret being to select investments that identify this value and have a track record of successively exploiting it to the full. For example, he says the M&G Recovery fund aims to identify shares which are out of favour in the short term, and offer good prospects of recovery in their price.

Another potentially positive indication is that we should be entering a falling interest rate cycle, a development that will help to boost the economy. Leaviss expects to see interest rates falling around the world to provide, in general, a good backdrop for bonds. "This is good news for bonds and as such, I believe we have seen the end of the bear market for government and investment grade bonds," says Leaviss. "These assets now look good value."

Neil Cumming, fund manager of the PSigma UK Growth fund, says interest rate cuts may also be good news for depressed industry sectors, including housebuilders such as Bovis, property companies such as Savills (SVS) and some retailers like Marks & Spencer. Several key themes look set to dominate the investment world in 2008. For example, green issues proved increasingly fashionable among investors in 2007 and this is a trend that looks set to continue.

Green with...profit?

However, a new breed of green fund has emerged on investor's radars - climate change funds.

Schroders launched the first Climate Change fund last year and its popularity meant several other investment groups, including HSCB, F&C, and Allianz Global Investors, were quick to see the opportunity that this new sector provides. The funds invest in companies that benefit from efforts to mitigate and adapt to climate change. Unlike traditional ethical funds, like 'dark green' funds which avoid companies that fail to meet strict investment criteria - such as companies that produce or manufacture alcohol - these new types of fund intend to invest in a much broader range of industries.

For example, if the Schroders fund found companies in the drinks trade that were helping climate change then it would be willing to invest. "The issues surrounding global climate change have gradually made their way up political agendas, particularly in the past year, but this is only the tip of the iceberg," says Simon Webber, manager of Schroders Global Climate Change fund. "Fixing the problem is not going to be done by putting up a few windmills and it is not going to be done by just a few more bus routes. It will require a complete transformation in the way the entire world does its business."

Another theme that looks set to run and run is emerging markets, which have produced some impressive returns in the past 12 months. For example, the best performing fund in the Equity Asia Pacific excluding Japan sector over the past year is the Old Mutual Asian Select fund, which has soared 54%.

Golden age for emerging markets

Christian Deseglise, global head of emerging markets business at HSBC Investments, says emerging markets are in a golden age. "Provided the world does not slip into recession, we expect the sweet spot in emerging markets to continue during 2008," he says. "The bull run has lasted for five years and we expect it still has further to go."

Emerging markets have seen huge development in recent years as their populations enjoy economic growth and the trappings of Western lifestyles. One aspect of emerging markets which has taken many commentators by surprise is the speed at which they rebounded when global equity markets were hit last year.

Deseglise points out that although emerging markets were not totally immune and did feel the pain of the global credit crunch, the strength of any recovery surpassed that of the markets in developed worlds. "Once seen as the high-risk element of an investment portfolio, the story during 2007 showed emerging markets are now safer investments," he adds.

Increased volatility

However, such investments are not without their risks and emerging markets can often be more volatile than their developed counterparts. But if you're willing to accept high risks in pursuit of high rewards, a new option is the first fund based in Britain to invest across the continent of Africa.

The New Star Heart of Africa fund is run by fund manager Jamie Allsopp, who points out there has been a substantial change across Africa. "The continent has tremendous potential for capital growth, particularly in its infancy as an investment destination."

He explains that the sub-Sahara excluding South Africa region has become an attractive investment destination due to the combination of strong economic growth, high levels of foreign investment, strong demand for resources and a low level of correlation with other world markets.

Back home, however, some sectors appear to be running out of steam. The housing market, for one, has finally begun to show signs of slowing down as the credit crunch begins to bite. Halifax, Britain's largest lender, reported that house prices fell by 0.5% in October, continuing the steady downward trend experienced since the end of 2006.

James Cotton, mortgage specialist of mortgage brokers London & Country, says: "The five base rate rises that took place in the year from August 2006 will have hit people's pockets, but many borrowers will have been protected from them thus far by fixed-rate mortgage deals. It is only when these fixed rates come to an end that the impact on their finances will be properly felt."

While there may be further volatility ahead, good planning and research will help you to minimise the risk to your investments and ensure that 2008 could be your most fruitful year yet.