RJH writes...

The 2006 global economic consensus forecast is a robust one. With generous liquidity and cheap money this is not a great shock - but both can bring problems. The key to a big year is whether markets perceive the US Federal Reserve as successful in managing inflationary pressures - notably central government spending on disaster relief, Iraq and Afghanistan.

The scribe's working assumption, subject to new information, is that that the next 12 months will fail to provide a clear-cut answer. Inflationary doubts will meanwhile increase and, in response, the broad US indexes will take high single digit losses into 2007. The main UK indices will score low single digit increases.

Discussion - a few components of the Working Assumption:

The potential for significant disruption is real. Determined, it seems, to go down as the man responsible for putting the 'mental' into 'fundamentalist', President Ahmadinejad's uncompromising nationalism and populism risks transforming domestic and international uneasiness into something more dangerous. There is little sign to date of any pragmatism from the President; and he does not seem the type of man who shirks confrontation: just how far along is the nuclear programme?

If the consensus for global growth is correct, it seems unlikely that energy will cheapen. Moreover, aggravation in Iran (perhaps in the form of military strikes against the nuclear programme; or, insofar as the cartel makes a difference, Iran-inspired OPEC price supports; or civil unrest) implies support for already expensive oil. Persistently high energy costs will appear more and more in finished goods prices and will take an ever-heavier toll on aggregate consumption.

US dollar
It may not have fallen in 2005 but from mid-2006 this is likely to change. Last year the Fed was in rate hike mode and this, coupled with looser foreign central bank policy, had a huge impact on the currency (and embarrassed dollar bears like the scribe). However, the most recent Fed minutes appear to show that this stance is changing - in contrast, for example, to the position of the European Central Bank that appears to be tightening. A weaker dollar might (ah, might) be enough to make the heroic US consumer start saving and diminish aggregate demand. Conversely, it will boost US exporters, but how much of an offset will that prove?

Corporate balance sheets
Strong in both the US and Europe and probably will drive solid M&A activity, share buybacks and investment expenditures in 2006. But is this as good as it gets for the current cycle; and are Delphi, GM and the automotive rest harbingers of a generalised deterioration in debt ratings?

US Presidential Cycle
Year 2, the one in which tough economic decisions are made in the hope the electorate forget about it come election time.

Oil and other resources will win if global growth is robust (but one probably has to believe the BDI will rebound). Oil will be the outstanding gainer if there are Middle-Eastern eruptions. Moreover, if the dollar is to decline, a US-quoted Canadian energy trust (for example) will make not only the crude gains but will also pay a handsome loonie-denominated dividend. Increased capex/investment expenditures stand to benefit any number of companies but there are a handful of especially attractive candidates compatible with the scribe's investment method that serve the utilities, oil & chemical and business process (software) sectors.

Disclosure: the writer has holdings in Canadian energy trusts, oil and resources

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