Sandy NairnFor a while the economic world was entranced with "decoupling". This theory suggested that world growth could be sustained by emerging markets, as they were not "coupled" with established economies, particularly the US, while the west weaned itself off its spending orgy.

Sandy Nairn

For a while the economic world was entranced with "decoupling". This theory suggested that world growth could be sustained by emerging markets, as they were not "coupled" with established economies, particularly the US, while the west weaned itself off its spending orgy.

Hence we did not need to worry about either excess consumption in the west or about the health of the global economy. All we needed to do was buy emerging market equities and wait for our wealth to accumulate. Sadly, it was not only implausible but also arithmetically impossible. It is difficult to believe that this rubbish was being peddled only two years ago.

Since then we have seen a vicious bear market as a result of previous policy mistakes compounded by the near collapse of the banking system. In an effort to mitigate the economic consequences of these policy errors, western governments have allowed public sector deficits to balloon. The net outcome is that we have recession, and the debate in financial markets has now moved on to predicting the profile of economic recovery.

I hesitate to participate in this debate but our planning is based on a view that all forms of taxes will rise in the coming years, and as such, growth will be anaemic and certainly lower than we have seen in the past 20 years. After a sustained period of excess consumption in the west we should anticipate an equivalent period of reduced spending. Somewhat paradoxically, we might see this combined with better profitability in industries which have recently struggled because of capacity and competition.

Consumption patterns are changing in Asia and will continue to do so. Asia is much richer than it was and this wealth will be reinvested in the west - and not just in US government bonds. It is likely that Asia will do what the west did at an equivalent period of its development, which was recycle capital in areas where it has a domestic shortfall. Expect further acquisition of raw-materials sources, distribution channels and intellectual property.

Which brings us back to decoupling. Identifying the underlying greater wealth and consumption in Asia was valid. The flaw lay in concluding that it could single-handedly save the global economy, and secondly that as a consequence we should buy emerging market equities. Time though has moved on. There is now no delusion about the situation and emerging market equities are nowhere near as exposed in valuation terms.

As you might expect, the structure of our portfolios has evolved. With valuation changes reflecting the above views, we have substantial exposure to emerging markets, to technology, and increasingly to industrial production capacity. In aggregate we see good valuations and are optimistic about long-term equity returns in both an absolute and relative sense. We think that the discussion about the shape of recovery will persist and scares will present buying opportunities. We remain of the view that cash is now your enemy and it is important to remain relatively fully invested.
Sandy Nairn is chief executive and investment director of Edinburgh Partners