Timing of recovery difficult to predict

By Alison Sinclair, investment manager Britannic Asset Management

How often have we heard the phrase, 'Its different this time?' But again and again this is proven wrong and we realise that nothing is really very different after all.

It is now over two years since the US Federal Reserve started easing monetary policy and rates have fallen from 6.5% to the current 1.25% over this period. So for two years we have been subject to research reports recommending which stocks to buy after each subsequent cut.

The returns have diminished somewhat after the 10th cut and the arguments have become less valid as time goes on. Indeed, meetings of the Fed have become less of a key focus for investors and Alan Greenspan's every word is no longer analysed to death.

At the moment, the main features for markets are geopolitical concerns and the war with Iraq. Unsurprisingly, direct comparisons are being drawn between the current Iraq crisis and the Gulf War of 1991. Analysis of how the market moved after every shot was fired has been scrutinised and economists and investors are trying to use history to help them predict where the market is likely to go from here.

With no evidence of sustained economic recovery, it has been easy to blame the crisis in Iraq for decisions made by companies to delay capital expenditure and investment. Again comparisons have been made with 1991. At this time too the economy was coming out of recession. Fair point, but in 1991 we were not suffering similar excess capacity as now, (due to past overspend) and interest rates were at a much higher level. Will it be different this time? This is a difficult question to answer. Yes, the market will respond positively to the removal of the threat of war and the uncertainties that it brings.

Unfortunately though, the conclusion of the war may not be the panacea that some expect. It is unlikely that companies will suddenly step up investment as soon as the conflict is over. Many will be keener to repair their damaged balance sheets.

High oil prices mean that companies are suffering a margin squeeze as they cannot pass the increases on to customers. Consumers are also being hit by unemployment worries, and higher petrol and heating costs. This could hamper future spend, especially as consumer confidence has been falling for the past year. The fiscal stimulus package proposed by President Bush should give the consumer more spending power but recent behaviour has seen savings from mortgage refinancing being used to pay down debts rather than spent.

Now that war has started the market is hoping for a quick resolution and the oil price has fallen from highs as Opec has stated that they can cover any shortfall in production from Iraq. The risk is that the war is prolonged and the uncertainty continues.

We have been waiting over two years for the US economy to recover and it will, as cycles will always move up and down. The conclusion of geopolitical worries will help, but it is unlikely to solve every problem. We believe that there will be economic recovery, but the timing is difficult to predict.

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