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Mark Dampier: Problems in China may throw out predictions

The Analyst

Although investment is for the long-term, over the festive period we all like to have a guess at what might happen over the course of the next year – and look back at what has happened in the last. Generally it is important not to get carried along with the herd if there is a strong consensus of views, which this year I suspect could be that emerging markets are the place to be. That is not to say the consensus is always wrong, but to me emerging markets seem neither particularly expensive nor particularly cheap, and as an asset class this puts them in a sort of no-man's land, which means they could easily rise or fall 20 per cent depending on sentiment.

By and large, I am fairly optimistic for stock markets in 2011, though admittedly there are plenty of significant macroeconomic factors that could blow them off course. The two main ones must be further eurozone sovereign debt problems and the potential for a slowdown in the Chinese economy. I have little doubt that at some stage a considerable amount of southern Mediterranean debt will have to be "rescheduled" – a word that European politicians prefer to default, but amounting to the same thing. However, a realisation of these problems might actually be preferable to the series of sticking plasters that the European Central Bank has been applying this year.

A Chinese slowdown caused by higher interest rates would be a bigger problem, particularly for commodities. So take care that your portfolio isn't facing just one direction, as emerging market and commodity investments are highly correlated.

Whilst emerging markets have done well this year, I am surprised at how many investors overlook their own stock market. Maybe we are too close to it to see the merits, but the UK Smaller Companies sector has had a cracking year, and one fund I have highlighted a number of times is Standard Life UK Smaller Companies, the third best in the sector, up over 45 per cent. If you bear in mind that the best global emerging markets fund is up just over 30 per cent over the same period, it shows that investors should not shun opportunities on their own doorstep, and I still think this area has potential.

Bonds have had a pretty good year too, despite widespread worries that they are overvalued. Although there has been some weakness recently due to sovereign debt fears, they have been able to build impressively on 2009's gains. However, risks lie ahead. The West is importing inflation from Asia and emerging markets, and at some stage interest rates will be forced up. Although I think they will remain low for a while yet, we may well see a first move towards the end of 2011. What this means is that bonds are generally becoming a more risky proposition, so investors in investment grade corporate bond funds should consider moving some exposure to more tactical or strategic funds where the fund managers have the ability to defend against a bond reversal, or even make money from it (providing they make the right decisions). Funds of note in this area include Jupiter Strategic Bond, Old Mutual Global Strategic Bond, M&G Optimal Income and Invesco Perpetual Tactical Bond. Should inflation carry on increasing over the next couple of years the potential for capital loss on bonds is quite large. These funds aim to help protect investors should this occur, though you may have to accept a lower level of income from them compared to regular bond funds.

Finally, whilst many absolute funds have not performed well over the course of 2010, I remain committed to Philip Gibbs' Jupiter Absolute fund as the very fund you want when things start to go wrong. I would dovetail this with Artemis Strategic Assets under the management of William Littlewood, who is more bullish than Philip Gibbs at present. I can think of no better fund managers to guide you through the next few years of unpredictable economics and stock markets than these two.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent