| 2004 has been a test of
patience for our asset allocation views. While corporate
earnings grew at a rapid pace, equity markets took their
time to reflect this improvement in fundamentals. Meanwhile,
investors who agreed with our overweight emerging Asia
equity stance had a torrid time in Q2 as these were
badly hit by high oil prices and an increase in risk
aversion. However, the performance in the second half
of the year has vindicated our stance. For bonds, while
our underweight stance has been vindicated to the degree
that bonds have generally underperformed equities –
as has our view that low grade corporate debt was likely
to outperform sovereign debt – we are still awaiting
a significant sell-off in bonds that we expect in the
face of rising inflationary pressures and burgeoning
fiscal and current account deficits, all of which may
reduce the incentives for investors to hold US bonds
going forward.
 Looking
forward to 2005, it appears very likely that some
sort of growth deceleration will ultimately be seen.
The global economy is extremely imbalanced and there
is a need for the US to cut its current account deficit.
This can either happen by a US dollar adjustment,
undermining export-oriented growth outside the US,
or a sharp slowdown in US demand (or both). The question
is whether the slowdown will be controlled or sharp.
This matters greatly for equity markets.
A gradual slowdown would likely enable companies to
retain a degree of purchasing power and earnings to
grow from their already high base, albeit at a slower
pace than experienced in the past 18 months. A sharp
slowdown, however, would be a different story as earnings
would fall quickly and the market could also reduce
the multiple they are willing to pay for those earnings
– resulting in a double-whammy for equity markets.
With valuations not over-stretched and our central
scenario for strong growth to continue in the first
half of 2005, we are holding onto our overweight equities
stance. But we will be very sensitive to signs of
a slowdown in global economic activity.
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Bulls and Bears 
