Why 2007 is going to be a difficult year for investors

It is hard to believe that some investors really think that US company profits can continue to merrily rise ever upwards with automobiles, housing, manufacturing and retail showing severe signs of strain. Or that the devaluation of the US dollar will not precipitate some kind of an asset sell-off as it did in 1987, as who wants to own assets valued in a depreciating currency?

Yet such is the madness of crowds and hyperbole of analysts that it is perfectly possible that the Dow-Jones could enter 2007 with a fresh all-time high. But this can not last, and by the spring at the latest Wall Street will find itself in serious deep water.

Now when the US catches a cold the rest of the world catches pneumonia. China is one-tenth the size of the US economy and can not provide an alternative motor for the global economy, besides it is very dependent on US exports. The Indian economy is smaller.

Now where to hide

Europe is already worried about the devaluation of the US dollar and the impact on the competitiveness of Airbus, for example. And Japan's anemic economy will be sorely tested.

So don't invest in global equities, mutual funds or even private equity for 2007. This could be a very rough year for equities and that also goes for Arabian stocks which will suffer from another side effect of the crumbling US economy: lower oil prices.

Oil producing countries can expect to see significant revenue falls in 2007 as global demand for oil will drop at a time when oil stocks are rising strongly. This will also be bad news for Arabian real estate, particularly off-plan speculation which has boomed on the back of high oil prices in recent years.

US Treasuries should fare better as a sell-off in equities will help rally or maintain the value of the US dollar while the Fed will doubtless cut interest rates in the wake of trouble on Wall Street and thereby boost bond prices.

It is arguable that hedge funds might perform well in a volatile year. But as we have seen in 2006 with energy price volatility that theory does not always work in practice; and a seven per cent average return for hedge funds in 2006 was hardly more than a risk-free bank account.

Avoid hedge funds

In a crash the multi-trillion dollar derivatives market traded by the hedge funds could come seriously unstuck, and could in extremis turn a recession into a depression. So avoid alternative asset classes like hedge funds like the plague.

In cash is perhaps where investors ought to stay for 2007. There is a risk of further US dollar devaluation, although a dollar rally would follow if asset prices undergo a strong correction as this article argues looks inevitable. We saw this in May this year.

The other option is to diversify into precious metals, although as next week's column will suggest it may be better to wait until the second half of the year because in a commodities slump gold and silver would also fall in value. But equally precious metals would usually be the first asset class to rally after a major global sell-off.