Over the last few years, the global economy has been enjoying strong growth and expansion in most parts of the world. Despite fears of inflation, a slowing US housing market, and geopolitical tensions in the Middle East, historically low interest rates, excess liquidity and mergers and acquisitions activity have been some of the key drivers of this economic expansion. While economic growth is expected to moderate, we see no significant threat of a recession. Rather, there are expectations of monetary easing on the horizon in the US as we head into 2007. Overall, we anticipate a modest deceleration in corporate profits, but there is not a seriously negative scenario that we can envision due to the healthy nature of corporate balance sheets.

The recent decline in energy prices, while negatively impacting stock prices in that sector, has given off a bullish signal for the broader market. Price increases may continue to be a threat into 2007 due to the potential for adverse weather, terrorist attacks and supply disruptions. However, we attribute this latest decline to the cooling down of global demand coupled with a benign weather pattern (particularly compared to 2005) and continue to subscribe to our “stronger, for longer” energy price thesis.

Consumer spending has withstood higher energy costs though the pressure from a housing slowdown and higher interest rates could begin to have a dampening effect. Initial reports from the beginning of the holiday season have been negative following a rare sales decline at Wal-Mart Stores despite overall retail sales appearing to be strong over the Thanksgiving weekend. If the US consumer does begin to show further signs of retrenching, perhaps with a more sustained downturn in the housing market, the ability of European and Japanese consumers to pick up where the US has left off will be crucial for the global economy.

European equities should continue to reap the benefits of restructuring and merger activity despite slowing economic growth. Consumer confidence is higher in Europe than the US, and business confidence remains robust despite some recent weakness. These are positive indications of a much healthier domestic economy. Although consumer price inflation is relatively benign at 2.2%, the European Central Bank will very likely continue to incrementally raise rates by 0.25% per meeting. That said, real rates remain relatively low, consumer savings are high and employment is improving. Consumption should continue to improve into 2007 at a moderate pace, with possible weakness in Germany due to an increase in VAT.

Japan is emerging from a decade of deflation and scarce local consumption. While recent domestic economic data has been mixed, the consensus belief remains that Japan’s economic recovery is on firm footing, which should continue to push domestic oriented stocks higher in the medium term. Still heavily dependent on exports, a US slowdown has weakened the Japanese market, a top performer last year. Japan is also facing a change in political power as Prime Minister Koizumi stepped down and Shinzo Abe took over. Much more needs to be accomplished, however, including postal privatisation and health care reform. Japan’s new Prime Minister Shinzo Abe has stressed the need for his administration to support growth and urged the Bank of Japan to do the same with monetary policy. As a proponent of economic reform, Abe is expected to continue many of Koizumi’s policies. By striking a balance between the cabinet and independent economic and security advisors, the new Prime Minister should be able to continue the Koizumi reform legacy.

We remain optimistic regarding emerging markets, with the caveat that, left unchecked, excessive fund flows could signal trouble ahead. Across emerging markets local consumption is taking hold, current account surpluses are the norm, not the exception, and governments appear relatively committed to economic reform. However, recent above trend performance enjoyed by investors is probably not sustainable.