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Financial trends affecting Investment

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Financial Trends affecting Investment

I have never been accused of lacking vision. That said, I am not always right. However, I thought I would share with you some thoughts on how the economy could go in the future, to help you make up your own mind about investments, not just property investments.

In any investment, there are a number of things to consider:

There is no use investing at the wrong time in something that you paid too much for. Hence having some insights and foresight as to how things could look in the longer term is important. Everyone has their own views and options – I believe it wise to flag emerging trends so you can also consider these when making investment decisions.

Dollar versus Euro Trends

How the Dollar and Euro play out over time can be important. The USA has a balance of payments deficit, with many people due to retire from 2004 onwards. The increase in pension provision for this aging population is likely to put additional strains on an already creaking economy. These additional social costs with the burden of the deficit could create a run against the dollar and a switch to the Euro and capital flight away from the US stock markets.

That said, the Euro is not exactly a safe currency – if Germany and France do not stave off stagnation and potential deflation, and a two speed economy develops between the Euro-zone fringes and the center, caused by one interest rate and convergence of taxation, this could eventually lead to the break-up of the Euro as a single currency. Growth in Western Europe and the USA may be more difficult to achieve. The doubling of income every twenty years is probably a thing of the past for these economic centres – hence any investment in these economic heartlands should be viewed with caution.

The question is, are the stock markets still potentially overvalued (ref: the price/earning ratio of the Dow Jones looks high at 23)? Will we be looking at sustained growth rates of 2-3% or something closer to 0-1%? As companies go global and relocate to low cost centres such as India and China, this will put additional pressures on employment, state funding and the social welfare systems in Western Europe and the USA. What will the additional pressures from Eastern European countries joining the EU on Western European economies. My message is to be very wary about investing in the stock markets in Europe and the USA, particularly after 2008 when many people will be retiring and there will be a huge pull on funds to pay for pension provisions (this peaks in 2016 in the USA).

Most Far Eastern countries have better demographics – a younger population to provide for vibrant growth and often a more flexible and mobile workforces at lower cost. These are likely to be the new growth areas in the future. If countries such as Thailand, Indonesia, China, Malaysia and India can achieve political stability, law-and-order, steer clear of cronyism and provide a stable vibrant economic climate for inward investment, these countries should provide the engine for global growth in the future – China should lead the way with India making strong contributions to global growth. The interest of the Far East in technology, telecommunications, manufacturing and tourism is a dynamic combination – the workforce are educated, intelligent, hard working and resourceful – I believe the Far East will impress in the future.

I also believe there is a serious risk of deflation in countries that do not have a flexible workforce, have high social costs, declining population, low immigration and an aging workforce such as Germany and Italy. The jury is out in the USA – they benefit from lower social costs, more flexible workforce and high immigration of lower cost labour, so I am less concerned about the US economy in the longer term, particularly if it can get its deficit reduced.

I am reasonably optimistic about the UK since it has population growth, higher immigration, is not constrained by one single interest rate and has a more flexible workforce than those of the Euro-heartland areas. You may think - why all this is important to me? The answer is that you have to invest in the right place at the right time. This summary merely provides some pointers to where you may consider investing or mitigating your financial risks, since ultimately you will need considerable financial resources to secure your retirement.

Do not assume your pension will be worth in 10 years time what you think it will today – the stock market may crash, your company may stop pension provision or both. When tens of millions of people start retiring on the USA and Western Europe in 2010, countries may get into massive deficit, raise taxes that stifle growth, reduce incomes and your pension. So watch out. Save and invest wisely in something you or an absolutely trusted financial adviser are knowledgeable about.

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What about Sterling versus the Euro or Dollar?

Be very careful investing in Sterling if you may one day convert wholesale to Euro or Dollar. The reason is that the UK Sterling is at a relative high currently against the Euro because of the high interest rates and buoyant economy (4% versus 2% in Euroland). If the UK joins the Euro – this could be as early as 2010 – though I would only give a 50% chance to this myself - interest rates would have to come down to Euroland levels and the currency would likely decline in strength as the economies converged.

Against the Dollar I would also see Sterling dropping in the 5 years time scale since I expect the US to recover partially from its huge deficit problems as growth is maintained. As a rule, I try and keep out of currency speculation – and have a philosophy of investing in the currency I consider I will retire with and spend in that country. Exposing oneself to the Euro has its attractions (I own a few Euro denominated properties), and the Dollar seems low at present, but I tend to keep my money in Sterling because I am a British national who is likely to retire and live in the UK.

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UK Interest rates

They will go up a bit, may be to around 5% eventually, but I believe with Euro-convergence of the pound and Euro over the longer term (say 5-10 years) and advances in productivity through new technology, “off-shoring” and competitiveness, will keep a lid on inflation and hence interest rates will stay relatively low for the foreseeable future. The inflationary pressures in the UK are rather benign – I would not be at all surprised if the highest inflation we see is in housing – either house prices or rental in the medium to longer term.

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