The traditional exercise of New Year forecasting looks even more perilous than usual in 2009, given the particularly poor visibility on the economic situation.

Simplifying just a little, we could summarise the economic cycle of the last 25 years as follows: the global economy was driven by the US economy, the US economy by consumer spending, and consumer spending by the increase in the value of real estate and financial investments (over the last 25 years, growth in consumer spending in the US has exceeded growth in disposable income practically every year, leading to a decline in the savings rate to almost zero. This lack of saving was not considered to be worrying, the reasoning being that with the increase in the value of assets people owned, savings were just happening naturally). This growth model seems no longer sustainable, but nobody knows what it will be replaced by. Faced with the weakness of private sector activity, governments have (re)discovered their Keynesian reflexes and decided to launch into massive programmes to increase public spending. It is still too early to judge the effectiveness of these programmes but the fact is that in most industrialised countries, the proportion of public sector to private sector is low (in the United States, the ratio is around 20%/80%. An enormous increase in public expenditure will therefore be necessary to offset a prolonged period of downturn in the private sector even taking account of the multiplier effect of such spending). What's more, in the longer term a growth model based on a continuing increase in public spending is neither sustainable nor desirable so another growth driver will need to be found to replace the American consumer. Of course, the American consumer could yet surprise us again (after all, the 'death' of the American consumer has often been prematurely announced in recent years). However, with high debt levels, very low saving levels, a dramatic decline in the value of financial and real estate assets, and a net deterioration in the job market, it's hard to see consumption recovering fast in the United States. Yet, if such a recovery is not forthcoming, a recovery in business investments seems illusory.

In the longer term, Asia is likely to replace the United States as the driving force in the global economy. For this to happen, however, the Asian countries will have to succeed in the transition from growth driven by exports to growth driven by internal demand. Such a transition will take time even if the measures announced by the Chinese authorities to improve social security via investments in education and health are encouraging.

As investors, we therefore find ourselves in unknown territory. In such a situation, the logical strategy would be to steer clear of risk assets and confine ourselves to high quality money-market and bond investments. But that would be to ignore the fact that the price of risk assets (particularly equities) has already fallen considerably (the fall on stock markets since November 2007 is one of the biggest ever recorded) and that the bad news must at least be partially reflected in share prices. On the other hand, the decline in money market rates (which is likely to continue in 2009) and in the yield on short-term government bonds has increased the opportunity cost of security quite significantly. In other words, an investor not wanting to take risks must be ready to accept low returns (but note that the low returns on risk-free assets are not sufficient reason to take risks. On the contrary, they reflect the seriousness of the situation).

Our investment strategy for 2009 (which is obviously likely to change as events unfold) will be based on the following ideas:

• There is currently a real risk of a very severe economic crisis. We therefore need to be extremely vigilant about the quality of the companies in which we invest (whether by buying their shares or bonds). A level of debt considered reasonable in normal circumstances could prove problematic in the current climate especially if a large part of this debt has to be refinanced in 2009 or 2010. Investors will fare better if they focus on companies that have the stamina to withstand a period of prolonged economic weakness. In 2009, the accent needs to be on the quality of a company's balance sheet rather than on its income statement;
  
• In an environment marked by economic recession and strong deflationary trends, (quality) long-term government bonds should continue to perform well. Many observers are of the opinion that a speculative bubble is starting to form in government bonds, citing the sharp rise in their price in 2008, low bond yields and the increase in budgetary deficits and public debt. Nevertheless, I think that at the moment, long term government bonds still have a place in a diversified portfolio, if only as a hedge against the risk of an economic nightmare scenario;
  
• Good quality corporate bonds are attractive provided they are issued by companies with little sensitivity to the economic situation. An investor purchasing such bonds must nevertheless be ready to keep them through to maturity if necessary. If this is not possible, price volatility and the possible absence of liquidity could lead to unpleasant surprises;
  
• For equity markets, the question will be whether the economic upturn expected by analysts in 2010 will happen. Investors have more or less given up on 2009 but if it turns out that the decline in profits continues into 2010, there will be a real risk of a severe additional downturn in share prices. Until we have a better visibility on the economic situation, I am maintaining a range of 600 to 1000 for the Standard&Poor's index (cf. my article of 7 December which explains why I have defined this range), the idea being to buy in the troughs and sell at the peaks of that range;
  
• Despite more solid economic fundamentals (at least for Asia), the stock market downturn has been even more pronounced on the emerging than on the industrialised markets. The recession in the industrialised countries is affecting the developing world, but the long-term outlook of the latter does not seem to be at risk. The fall in prices should therefore be used to establish or increase positions in the Asian markets provided the investor can tolerate the volatility which is liable to be a feature of these markets. The challenge for investors is to find companies that will profit from an increase in internal demand whereas the region's indexes are generally dominated by exporters;
  
• In an environment of low interest rates, high dividend companies represent an attractive investment provided the dividend is well protected. As is the case for corporate bonds, an investor should focus on companies with low economic sensitivity.