Gold prices are expected to weaken slightly in the first quarter of 2008 as the US dollar attempts a counter-trend rally on the anticipated end of the rate hike cycle. However, with the secular US dollar downtrend likely to resume beyond that, investment in gold for the medium to long-term looks to be a good choice.

THIS has been a good if eventful year for most investors with many emerging markets making record highs. Europe and Asia ex Japan have made very decent gains too. The equity market has been driven mainly by excess liquidity, cheap money and moderate valuations.

Despite a very good year for equities, there were occasions that caused some panic. The first of these were the curbs imposed by Beijing to cool the Chinese stock market in February. This triggered a global equity sell-down, and rattled investor confidence. However, it also led to a healthy correction rather than the start of a bear market.

Another notable event was the sub-prime mortgage-led credit crunch that started in July. The market has since recovered and even surpassed previous highs. Despite the volatility, the bull cycle continues.

There is a lot of talk about the decoupling of the US economy from the rest of the world's economies. No doubt, Europe, Asia and the other emerging markets are making tremendous headway in terms of GDP growth. Yet, all eyes will still be on the US. As the world's largest market in terms of capitalisation, and the leader of the pack, the stability and progress of the global economy still rests largely in the hands of this superpower. Given the volatility of 2007, what can investors look forward to in the year ahead?

Equities outlook

The global equity market will remain on the uptrend but one can expect the ride to be a lot rougher. After all, it was not too long ago that markets were reeling from the traumatic credit and market crises. However, major markets like China and Hong Kong have since reached new record highs. Furthermore, with the US Federal Reserve adding liquidity, it is likely that asset markets will continue to drive forward in 2008.

On this note, we continue to favour equities, in particular, Asia ex Japan, emerging markets and Europe. Valuations in these economies may not be considered cheap. However, with the exception of China and Hong Kong, they are not viewed as overly expensive either, and investors may consider having a closer look at these options.

In general, equities as an investment have provided investors higher returns than other asset classes, although the corresponding risk is also higher. With proper asset allocation and investment over a longer period, investors should be able to create a portfolio that is able to withstand market turbulence. Many banks offer products that allow investors to spread their portfolios across regions. One example is Standard Chartered's World Trader that enables customers to buy directly into five global markets - the US, the UK, Singapore, Hong Kong and Japan.

Alternatively, rather than entering the market directly, customer may consider Equity Linked Notes (ELNs). ELNs are short tenor (typically two weeks to one month) non-principal protected investment products which pay a coupon rate based on an underlying stock. At maturity, customers may receive either redemption proceeds in cash or take delivery of the underlying shares, depending on the terms of the ELN. ELNs are structured for investors looking at yield enhancement or for customers looking to invest in selected stocks at a discount to the current market price.

Fixed income outlook

Despite the Federal Reserve cutting rates from 5.25 per cent to 4.5 per cent in 2007, US 10-year Treasury yields have changed little. The year began at 4.7 per cent, and they are now trading at around 4.4 per cent. This could be attributed largely to the market which has already discounted the Fed rate cuts.

The view is that we are in a late cycle equity bull market and characteristic of such markets is their vulnerability to periodic crises and shocks. Therefore, we maintain a neutral weighting on bonds to balance out a long position in equities as a protection against the unknown.

Fixed income instruments will always have a place in an investor's portfolio regardless of whether it is a bull or bear market. Bonds are recommended to provide stability in returns and to cushion against any equity market corrections. At the same time, investors should note that bonds tend to offer lower yields because they are by nature, low-risk instruments. Furthermore, the return on bonds tends to under-perform the equity market. However, the benefit is that bonds hardly lose money except in the case of defaults.

Today, banks offer a wide variety of fixed income instruments, such as Singapore Government Securities and corporate bonds. Banks also provide investors who prefer to take a more diversified approach access to bond funds managed by both local and international fund managers. These bond funds invest in a variety of issues from different countries and can have exposures to either investment grade or high yield issues.

The more sophisticated investor may find interest in products such as retail bonds. Once a product only applicable to the high net worth with minimum investment amounts of $250,000, retail bonds are now more accessible. A retail bond is a debt obligation issued by various entities that promises to pay a regular coupon over a period of time. Investors will evaluate the bond on the credit rating of the issuer, coupon amount, tenure and yield to maturity. A key benefit of retail bonds is that they allow investors to invest in smaller amounts of about $50,000 by aggregating orders from a few investors.

In the long run, investors should stay put in equities but at the same time hedge out their positions by investing into medium-term notes or other forms of fixed income instruments. Volatility is expected to rise in the next 12 months and investors with weak hearts might want to take note. Investors who are reaching retirement are advised to initiate positions into more stable products so that their retirement funds are not affected by market movements.

An alternative asset class to look at in 2008 would be gold. Gold will continue to look bullish on the longer-term weakness of the US dollar. Gold prices are expected to weaken slightly in the first quarter of 2008 as the US dollar attempts a counter-trend rally on the anticipated end of the rate hike cycle. However, with the secular US dollar downtrend likely to resume beyond that, investment in gold for the medium to long-term looks to be a good choice. Given the numerous investment products available in the marketplace, how does one understand them and evaluate their merits? How does one maintain a balanced approach? We suggest a four-pronged approach.

• Know the characteristics of the underlying. Is it a play on interest rates, equities, indices, commodities or currencies?
• Analyse the potential for the underlying(s) to perform well. What market view does the product hold of the underlying? Is there a well thought-out investment thesis?
• Scrutinise the payoff conditions of the underlying. Be sure you understand them fully and that they are in line with your risk appetite. Are you a risk taker looking for a "booster" to augment your views or are you looking for capital protection while seeking a measured exposure to investments?
• Understand the risk-reward paradigm. Higher returns expectations are coupled with undertaking higher risks. It is important to align your returns expectation and risk tolerance level to your investment choices.

Dennis Khoo is general manager, wealth management, Standard Chartered

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