US and Japan reverse tables and signs of deleveraging continue

If ever you needed a convincing argument for active asset allocation, this year has provided it.

Last year the two worst-performing equity regions were the US and Japan. As we stand, comfortably beyond the halfway point of the year, those tables have been reversed. So far this year, the US and Japan are the best-performing equity regions - though I hesitate to say strong performers (with losses of 12% and 7% respectively in sterling terms).

Clearly we are still in the middle of massive deleveraging following a lengthy credit binge. This has been coupled with inflationary pressures driven by increasing demand for oil and commodities and with prices fuelled by speculation (albeit the heat has dropped on these more recently). This has put pressure on consumer pockets and led to slowing economic growth across the world.

Developed regions - the UK, Europe, Japan and even the US - could be headed for recession. Emerging economies are not immune but have had growth rates at loftier heights so continue to remain robust.

During this period investors have dumped perceived 'risky assets'. In equities, last year's best performing regions - the Far East ex Japan and emerging markets - are the worst in 2008 year to date.

So far then, according to script for us. We argued at the end of last year that emerging markets were looking stretched and though we are still committed to the emerging markets story in our longer-term strategic asset allocation outlook, we took the tactical decision to go underweight short term and to go overweight on developed markets..

We have been particularly committed to the US and remain so. The forthcoming US presidential election will be the tenth election since 1970. Looking back on the last 38 years, the three months leading up to a US presidential election have seen returns of 5% on average (annualised to 20%). In non-election years the average returns have been 1% (4% annualised - all figures in US dollar terms).

The US was the first into this crisis and we believe it will be the first out. We remain overweight. As for Japan - always a much more cautious call for most of us - it is clear that the Japanese banks have had less exposure to the toxic debt related to US housing and personal balance sheets are in much stronger shape than in other parts of the developed world.

Looking at the markets generally, the problems are not going away soon. Credit will continue to be tight until the banks have rebuilt their balance sheets and in the medium term the pressure on commodity prices will remain as developing nations continue to emerge. There is potential for short-term, supply-side shocks that will see price spikes in individual commodities.

This all presents continuing tactical asset allocation opportunities and threats that makes the need for active portfolio management increasingly important.

Categories: Investment

Tags: Asset allocation

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