EUROPE - A rise in volatility and a fall in liquidity during 2007 will drive investors towards higher quality assets, while commodities are set to take a breather, according to Merrill Lynch's 2007 outlook.

Khuram Chaudhry, chief European quantitative strategist for Merrill Lynch in London, said that the market is likely to discount a slowdown during 2007 and investment opportunities will be driven by a likely rise in financial market volatility.

Presenting the Merrill Lynch year ahead 2007 investment strategy themes, he warned: "We are moving into a slowdown, the asset allocation is very different in a boom than in a slowdown."

In 2007 investors should look towards short-term treasuries, the defensive sectors and high quality assets: "We are taking risk off the table and adding quality to our investment style performance," Chaudhry said.

The five themes that international investors should consider in 2007 according to Merrily Lynch are: "The attractiveness of global telecoms; a shift to higher quality assets; consumer-facing stocks in emerging markets; and easing of commodities growth; and the role of gold in geo-political risk," the firm said.

According to Chaudry, 2007 will be the year of the dividend, as the firm expects high dividend yield, rising dividend growth and ultimately total return will start to matter a lot more.

The firm also expects that equities will marginally outperform bonds, but non-US equities will see a slower rise than before as the high risk appetite that could be seen in December wanes.

Elsewhere, Aberdeen Asset Management also said that it believes the trend of companies returning large amount of surplus cash to shareholders via buy backs and increasing regular dividends, and special distributions to shareholders will continue in 2007.

The firm added: "Despite a recent excellent run, UK equities remains attractively valued in terms of historic price-earning ratios. Company earnings' growth generally also remains strong, with M&A activities, in particular amongst mid-cap companies, continuing to support ratings."