By Jeremy Gardiner, director, Investec Asset Management

It is important to stress from the outset that the world is not fixed. Sure it is fixing, but there is a big difference between fixing and fixed. Growth is improving, unemployment is falling and stock markets are firm.  The problem is that it remains unclear at this stage how much of that is due to quantitative easing (printing money) and unsustainably low interest rates.

The fact is there are still a lot of consumers, companies and countries that remain geared to the gills and are struggling to keep their noses above water. Ideally, the world needs two boring years to recover; two years of solid stable growth, with no surprises in order to allow growth to get going again and to allow everybody to reduce their debt to more reasonable levels. 

The first quarter of 2011, however, was anything but boring. Some of the turmoil experienced during the first quarter was predictable and some of it not. So what then have markets had to endure over the first quarter and what will the impact of these events be going forward?

The Japanese earthquake for example was impossible to predict. While devastating from a humanitarian perspective, it scared markets temporarily, but the overall impact on global markets appears limited. Expect roughly 0.5% to be shaved off Japanese GDP growth as a result.

The turmoil in the MENA (Middle East and North Africa) region, although somewhat predictable given the lack of democracy and tyrannical rule, could never have been predicted from a timing perspective. Aside from the inevitable shock to regional markets, the global impact thus far is also somewhat limited, other than being responsible for an oil price that at current levels is significantly higher than the current volatility warrants, which implies speculation. The threat to the world of a shutdown in Libyan oil supplies is reasonably limited. However, if Libyan disruptions extend to Saudi Arabia, the impact on oil prices and thus global markets would be immense.

The first quarter also saw more of the ongoing financial trauma in Europe. With Greece and Ireland successfully resuscitated, at least for the time being, the world’s attention has turned to Portugal. Portugal’s needs are relatively small; Spain on the other hand is going to require a lot more Euros to plug the leak. Spain claims that they won’t need a bailout, but then so did Portugal, two weeks before they eventually did need one!

Will this be the year in which the Euro finally unravels? This is currently a subject of much debate and there are very clever people and arguments both ways. We certainly can’t predict what is going to happen. What we can say, however, is that it wouldn’t suit Germany for the Euro to fail, as the Euro is helping drive a rampant German economy. Germany has the lowest unemployment in 18 years, a booming economy, near zero inflation and the Euro is much weaker than the Deutsch Mark would have been if it were a stand-alone currency. Not irrelevant is also the fact that German banks hold most of the troubled countries’ debt, so a euro collapse would upset German banks considerably.

Last year was all about emerging markets. This year, almost like a tide that has turned the story has been all about developed markets, as they offer more value. Net flows for the first quarter were almost exclusively into developed world equities as opposed to last year’s almost exclusive flows into emerging markets. However, despite being less reasonable from a value perspective, emerging markets will continue to grow faster than developed markets and will therefore continue to attract flows, ensuring reasonably robust equity markets. This diversion in flows is good, as had emerging markets continued to have the perceived monopoly on growth and continued to take all the flows, the risk of an emerging market bubble would have become more pronounced.

So what should investors be most nervous of going forward?

• Middle East disruptions spreading to Saudi Arabia. This could drive oil to $150 per barrel and beyond, thereby fuelling inflation and with it interest rates.
• There will be more trauma out of Europe. Spain’s needs are significant and they may well need help. If they need help and don’t get it, expect turbulence. However, given the fact that it is both within Germany’s interest and control, expect them to probably get the help they need.
• Inflation is rising, driven by food and fuel. Expect rising interest rates, the extent of which will depend on these two factors and their impact on growth. In South Africa, in addition to food and fuel, we need to watch the rand as well. If the rand were to weaken substantially, that would also raise inflation. At this stage we expect two 50 basis point rate hikes before year-end.

So what should investors be doing during these troubled times?

• Don’t avoid emerging markets. Yes, they are overpriced relative to developed markets, but they will grow faster and they will attract flows, which means that their equity markets should deliver reasonable growth. 
• Before you rush off to invest in Russia, don’t forget that anything that you own in South Africa already counts as an emerging market investment and is a portion of your portfolio.
• Don’t avoid US equities or the US dollar. Both have had a torrid time for a very long time now, but this won’t be the case for ever, and there is a lot of bad news already in the price. Similarly with Europe. The US, Europe and the UK have already priced in a credit crunch, housing collapses, currency collapses, zero growth, poor if any equity performance, over-geared and sometimes bankrupt consumers, companies and countries etc. And they say you should buy when the news is bad not good! Yes, there is still bad news to come, but a lot of that is already priced in.
• Don’t try and time your movement between the various asset classes. You will cause yourself unnecessary stress and chances are you will be acting on emotion rather than fundamentals. Choose a good balanced fund manager. They will make the decisions for you; they won’t always get it right, but given their training, experience and access to information, a good portfolio manager should get it right more often than you!
• Don’t invest in schemes that promise fast and returns higher than everyone else, sold by companies with no brand or reputation. Too many people are losing their hard-earned savings to unscrupulous financial salesmen. There is no difference between a thief who robs you on the street and a financial services crook. The latter is generally better educated, sounds more erudite, dresses better and steals more. Beware, they are out there. 
• Don’t invest in anything you don’t understand. Chances are the salesman also doesn’t understand what it does, and if it all falls in a heap you will regret backing exotic products. 
• Most importantly, diversify everything. Don’t try and be too clever. Go back to basics; honestly assess your risk profile based on your financial circumstances, not on gut feel about where markets are going. Make sure your portfolio is appropriate to your risk profile – too many people adjust their portfolios based on what markets have done and expect them to continue doing the same, whether that is rise of fall, when often markets do the exact opposite.