Some bold predictions and qualified advice for daring investors in 2004

President Bush is determined not to repeat his father's mistake of winning a war and losing an election by ignoring the economy. He has pumped massive fiscal stimulus into the US economy, and the US budget deficit has been further boosted by military spending and the reconstruction of Iraq. So far at least, domestic and international financiers seem more than happy to finance the massive US budget deficit and US long bonds have risen by only 100 basis points from the very low yield of 3.10 per cent reached in early 2003.

The US current account has been blown out by US trade being uncompetitive. The rise of the US dollar and the strength of China's economy are the two main factors here. The long reduction in the value of the US dollar has further to run and will gradually help improve the US trade position. But if the US trade account fails to improve fast enough, loss of confidence by international investors could cause a flight from US-dollar assets with consequent instability in global financial markets. These markets are very resilient, but a perceived US trade crisis could have powerful adverse effects, especially if the US seemed determined to retreat from its current doctrine of relatively free trade.

House prices have risen sharply in several Western nations - over the past year by around 20 per cent in Australia, 25 per cent in the UK and about 10 per cent in the US. The Economist magazine during 2003 put a fair probability of a serious correction in house prices in these countries in the next few years - but such a correction seems unlikely to achieve the status of a serious X-factor in 2004, except possibly in Australia.

The most likely, as well as the potentially most serious X-factor in 2004 is the same as in 2003 - a major new terror attack, or series of terror attacks. It seems probable that action around the globe has reduced somewhat the capacity of the agents of mass terror. But it is also evident that their capacity has been great and is still far from negligible. But resolute overt action in Afghanistan and Iraq, and covert action in many other places have reduced the risks of a major terror event that could do major damage to the global economy, or to confidence in global economic recovery.

A senior mining man suggested to me that another possible X-Factor is that China might not be the economic hope all are assuming it to be and that it might actually implode. He wrote:

When everyone in the media seem to be waxing lyrically over China's stupendous economic growth, and the economic benefits it will bestow on our mineral industry, I just wonder, because the mob I do some work for dislike intensely doing business with them, from bitter experience ... Other than a Chinese economic collapse, how about the Indian subcontinent exploding after Mushareff is assassinated? Powder keg there.

Economic guru Alex Erskine suggests that the rise in productivity growth in the US is the real X-factor of 2003 and into 2004:

It is the only effective counter to China and India, and it will drive a further wedge between sleepy Europe and dynamic America. Which side will we co-habit with? Our productivity performance says 'Europe', but our trade negotiations and the commodity surge say 'USA'.

So what are the implication for investors in all this? Of course "it all depends" on investors individual wealth positions and appetite for risk. "Consult a Financial Planner", sacrifice a virgin and read Henry Thornton's Six rules for building wealth before getting too adventurous. If your financial planner, your spouse, your accountant and your physician have all cleared you for take-off, however, here is my advice.

"More of the same" seems to be the short-term message. The adventurous investor should be mostly long equities (especially the major resource companies), long commodities and short bonds and fixed interest. Equity and commodity markets surged late in 2003, and this is a bit of a worry. Waiting for a negative shock to provide better entry points seems unlikely to be the best strategy.

Choosing carefully which assets to buy (or sell) in which counries will provide a particular challenge. Asia will very likely be one of the strongest areas of the world in 2004 but, unfortunately, gaining access to some relevant markets is difficult for any but the most professional investors.

Picking the timing of the inevitable increase in global bond yields will remain vital and such a move seems far more likely in 2004 than it was in 2003. Once US bond yields begin to rise, investors should become especially wary of growth assets.

There will be money to be made as the Australian and New Zealand economies flirt with the possibility of serious setbacks caused by possible crises of confidence by international investors. If the Aussie dollar gets above US0.80 (as I expect), the chances of a crisis will rise exponentially. The Federal election in Australia may also provide a particularly juicy money-making opportunity for the bold investor.