Evercore Pan Asset

Last year we recommended a very cautious strategy based around cash. Holding money in good quality deposits earning in excess of 5% felt comfortable, whilst we waited to see just how bad the downturn and the Credit Crunch were going to be. Putting some of the cash into stronger currencies than sterling was a way of raising the returns without too much risk.

This year is not so straightforward. The returns on cash on both sides of the Atlantic have plunged, leading investors to consider taking more risks. Sterling has devalued by more than a quarter last year, with much of the fall occurring in the last few months. Equity markets have fallen a long way, especially in the Far East where growth is still stronger and the financial position better than in the US and UK. US and UK government bonds have surged on the back of the falls in interest rates, offering low yields to new buyers.

So what should an investor do now? If this were a normal cycle it would be easy. You buy equities as interest rates fall, and wait for the turn to come in the underlying economies as lower interest rates work their magic.

The issue before us is the state of the banking systems in the US, UK and Euroland. They remain very weak. There are worries shared by investors, commentators and the authorities that as a result this is not a normal cycle. Lower interest rates may not flow through to increased activity, as the banks remain unwilling or unable to lend much. Final demand for the bigger ticket items like homes and cars has fallen sharply owing to a lack of credit. Businesses struggling with reduced order books then find it expensive or impossible to borrow all the money they need to tide them, through poor trading. Some go bust, and many make staff redundant. Rising unemployment depresses the wish and the ability to spend, further reducing demand. As more companies go under, as house prices fall further uncovering the asset cover for mortgages, so banks have to write more off their loan books and experience more bad loans.

There are at least three possible scenarios from here. One is that the banking problems are so severe that none of the actions being taken can mend them quickly, leading to prolonged recession or slump. On this analysis investors have to learn to live with low returns, and remain cautious as there will be more losses in shares and properties. The second is that time will produce a cyclical upswing, given the huge sums the authorities are pumping into money markets and economies, so now is the time to buy equities. Indeed, if the authorities do not reduce the extra liquidity in time there could be a future inflation problem, given the scale of interest rate cuts and the money supply boost. The third is that the authorities will eventually produce measures which enable some modest improvement in bank lending, which in turn will lead to a very slow and mild upswing. On this scenario the Western economies will have to get used to no growth and slow growth for quite a time whilst the debt overhang is worked through.

We cannot be sure which of these will develop in 2009. In part it depends on what the authorities do next. Can they, for example, hit upon the right combination of regulatory and monetary responses which can get their banking systems and economies moving again? It remains in the balance.

So we try to set out what seems more likely. We think the Asian economies will still grow faster and perform better in the years ahead than the Western ones. The fact that their share markets have fallen further will represent a buying opportunity over the early months of 2009, to add to positions in that part of the world. Corporate bonds offer a much more attractive yield than government bonds or cash. We recommend buying some of the best quality ones on a portfolio basis. If economic recovery develops, they will be re-rated. If we muddle through you should be able to enjoy the better income, and in a slump they will outperform equities and junk bonds which will suffer further from rising bankruptcies and falling profits.