A couple of years ago, every self-respecting company started to invest in emerging markets. Expectations of high sales volumes and attractive financing possibilities facilitated the expansion into new high growth markets. Since the summer of 1997 an increasing number of these emerging markets have found themselves in trouble. Financial crises, decreasing commodity revenues and restrictive fiscal policies have reduced demand from developing economies. This lack of demand is confronting the world with global excess capacity.

Governments in Europe and the US are well aware of their responsibility to reduce excess capacity by supporting economic growth. Especially in the US and UK there is large scope for monetary easing and fiscal loosening. This is more complex in Euroland: the Maastricht treaty limits fiscal stimulus and the ECB has to deal with inflation differences within Europe. Despite pressure from left-wing politicians to lower interest rates, we believe we have seen most of the European action for the time being.

Emerging markets provided additional economic growth to the world economy for many years. In 1997 emerging markets represented 40% of global economic growth. Their contribution has now changed into add-ing deflationary forces to the world. As inflation rates in the OECD area are already quite low, equity investors are now becoming increasingly nervous about deflation.

We firmly believe that in an environment of limited deflation, stocks will outperform bonds as long as there is enough real economic growth to in-crease corporate profits. However, volatility will be relatively high be-cause equity investors will from time to time question whether future economic growth will be sufficient to offset the deflationary forces on corporate earnings. Limited deflation is not immediately a problem for equity markets. However a restrictive monetary or fiscal policy will hurt volume growth and result in a depression as we have experienced in the US in 1929 and in Japan in 1997.

We believe the IMF and central banks are committed to prevent a global financial crisis and a further increase of excess supply, by focusing more on pro-growth instead of anti-inflationary policies. This is a buoyant environment for equities. However, economic risks in Latin-America and Japan prevent us from overweighting equities compared to bonds.

We see a weakening of the yen versus US dollar as the major risk factor which will turn investors sentiment in favour of bonds. While long term fundamentals remain attractive for equities, AEGON The Netherlands institutional portfolios - given the current economic risks - have a neutral allocation at the moment.

Within equities we slightly overweight European markets at the expense of the US and Pacific, because the earnings outlook for companies in continental Europe is more attractive than for the other regions.

The deviation in our equity portfolio's in terms of currency exposure away from the benchmark is an underweight allocation in pound sterling in favour of the dutch guilder. Sterling should depreciate as the Bank of England aggressively eases over the next 12 months in an effort to support a very weak economy.

Artino Janssen is head of strategy at AEGON Beleggingen Nederland in The Hague.