Evercore Pan Asset

2011 is turning out to be a very different year from 2010, as we thought when the new year dawned. We have been changing our portfolios to reflect the likely new conditions.

We forecast the one of the most important characteristics of 2011 is the move to higher interest rates worldwide. We have a two speed world. In the first half of 2011 emerging market economies will be tightening their monetary stance considerably, to combat rising inflation. The west will be slower to do so, with the US still printing extra dollars to stoke the recovery. This in turn is helping increase commodity price inflation further, leading to more attempts to offset in the emerging market world by imposing still higher interest rates and stricter controls over bank lending.

We decided to shorten the duration of our sterling bond portfolios ahead of any move to higher interest rates in the UK. The Govenor of the Bank may continue to be reluctant to hike official rates, but they only have one way to go at some point in the future. He is also coming under more market and pundit pressure to raise rates sooner rather than later, given the high level of inflation. Rising rates will be especially bad news for longer duration gilt portfolios, where we have no holdings. Corporate bonds have some protection from their higher yields, but they too can be affected by rising rates.

We remain strongly of the view that emerging market economies will be the winners of the decade, and their share markets will normally outperform developed markets. However, at this point of the cycle where the emerging markets are seeking to slow their money growth and output growth sharply whilst the US powers ahead with very loose money, you would expect developed markets to have a better relative performance. We have made some tactical adjustments to reflect this possibility. We sold out of India before the end of 2010. This market has been particularly hard hit by the change of sentiment, with a big reversal of the relationship between investment inflows and outflows and a drop in the share indices.

The world economy should grow by a reasonable amount this year. The first half is likely to be better than the second. As the year advances China, India, Brazil and the others will start to feel the effects of tighter money, and after June the US will probably abandon quantitative easing. As developed markets rise and as the year advances it will become more difficult to find value in shares, as investors turn from bullish thoughts and their current love of risk to worrying about the slowdown. We remain nervous about Euroland, where many of the difficult decisions about economic governance of the area remain to be taken in March. We are watching progress with stabilising the weaker banks in the Euro area, and fear there could be more problems with Ireland, Greece and Portugal.