The global economic and investment outlook over the coming year hinges largely upon developments flowing from Asia and Japan and the robust pace of global economic activity will slow as a result of these developments. The impact on activity outside the region is difficult to gauge precisely, but of the major industrialised nations the US, and to a lesser extent the UK, stand out as being most vulnerable. Although not unshielded from the Asian fallout, Europe will be relatively well supported by EMU activity.

Against the prospect of slowing economic growth, strong disinflationary forces and the subsequent softening of interest rate expectations, international fixed interest markets should perform well in the year ahead. This gives us a preference for bonds in our asset allocation. Within this we would bias holdings towards US treasuries and UK gilts. These offer good value given our growth and inflation outlook and the safe-haven status of the dollar and, to a lesser extent, sterling.

Equity markets, although now off their highs, are still taking too much for granted in terms of earnings ex-pectations for the year ahead. The essence of this argument is that there is a threat to multinational earnings as a result of lower growth on sales in Asia and that the strong dollar will have an adverse impact on exports and on the conversion of profits back into dollars. In addition and arguably of more concern are the 'second round' and indirect effects from Asia.

This economic uncertainty coupled with our view that expectations of market earnings are unrealistic leads us to be more cautious on equities. However, we are advocating only a modest underweighting because of strong cash flows available for equity investment, high levels of corporate liquidity and the supportiveness of the bond market. Nevertheless the risk of earnings disappointment makes stock selection paramount.

Within the US, UK and Europe we would bias our selection towards domestic issues where margins and sales are relatively immune from a slowdown in economic activity and disinflationary pressures. Our preferred region is Europe, where we see interesting opportunities in countries benefiting from sharply lower rates as a result of EMU. Our least favoured region is Asia where we think the turmoil has further to run. Although we advocate being underweight in the Asian markets as a whole, we are very positive on the large Japanese multinationals. Many are on internationally attractive valuations and are set to benefit from further yen weakness against the major currencies. Individual opportunities will also emerge in the rest of Asia in companies that are able to reap the rewards of a domestic cost base that has collapsed, in some cases, by more than 50%.

Tim Wilson is with Newton Investment Management in London

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