Where business will be next year

The beast blinks, and stumbles to its knees. Bloodied but hardly unbowed, the liberal model of market capitalism – the creature that so many once thought invincible, untameable, destined always to dominate our world – now totters uncertainly into 2009. But where is it going? How will the beast fare in its many market manifestations? I am pretty confident that most of the things I am arguing for in this week's column will come to pass at some stage. But, as we all know, timing is everything.

HEDGE FUNDS

For what it is worth, there is renewed interest in a collection of satirical essays I published with UK publishers Orion in 1995. A Fool And His Money, subtitled High Life, Low Living: Understanding Financial Markets And Those Who Work In Them, took a lampooning, oppositional view of the marvellous madness that is the free-market economy and the outrageous behaviour of some of the people working in the system.

The book hardly needs an update – it is still pretty accurate, and the chapter on hedge fund managers, where the argument runs that "black box" investment management is not understood by governments or regulators, or in many cases, the senior management of the hedge fund company – all seems so very prescient.

Except, of course, that the prescience just sat there and was defied by the facts (or the apparent facts, in the case of one US-based Ponzi scheme). You would have made a lot of money out of picking the right hedge funds in the mid-1990s.But the point in the book remains valid: some of the algorithms are so complex that a doctorate in mathematics from Harvard is the base camp for people who really want to try to understand them. So they cannot be regulated properly. Witness earlier comments, cited in this column, from the good people at Oxford's 21st Century School. This inability of government and regulators to comprehend means there is systemic risk. The black box can provide perfect cover for crooks.

Figures vary as to how much money is managed by "hedge funds" (I use quotation marks, since there is no universally accepted definition of what a hedge fund is). Niall Ferguson, in his brilliant book, The Ascent of Money, asserts that in 1990 there were just 610 hedge funds with $38 billion (Dh140bn) under management. This time last year there were more than seven thousand vehicles, with $1.9 trillion under management expect the crisis of liquidity and confidence to hit hedge funds badly in 2009.

That figure will be smaller by at least one-third now, I believe. I also expect a crisis of confidence and consequently of liquidity in this sector. The redemptions will flow. This will expose the scam artists – and almost everyone seems to be suspected of trickery in today's fearful world. There will also be another large failure, triggered by liquidity issues. The managers of Long term Capital Management, a hedge fund that went under in 1999, still insist the strategy was good, the portfolio sound – it was just that people did not understand. So expect at least one more scam to be revealed, and one major failure.

EQUITIES

Equities will trade sideways – in a band of 10 per cent either side of where we are now – almost across the world. Equities will still be held, but not traded as aggressively. Even people who are supposed to understand systemic risk and volatility will not be making aggressive plays. George Soros, whose calls have been – more or less – consistently accurate, bought into Lehman Brothers just a few days before the bank collapsed. Equities will be held for the long term by pension funds. The market game will be less ferocious.

This is subject to two provisos. One is a major, systemic shock and the other is China. I believe the Chinese equity market will finish the year 25 per cent lower than where we are now. Why? Because the country's economic growth rate will drop to zero. The government will be pre-occupied with quelling civil unrest as disillusioned workers head home from the cities back to rural poverty. Dangerous stuff.

PROPERTY

There will be blood on the walls. Key areas such as prime residential London and (I hate to say it) luxury residences in the Gulf generally will have little fresh money coming in. The good news is that you can live in your investment. The bad news is its value would not be going up any time soon. And if you know a real estate agent, book him in for a retraining and skills development course. There will be many redundancies in this sector.

CURRENCIES

The euro is going down against all major currencies. UK Prime Minister Gordon Brown's package of measures to reflate economies is not going to have the desired effect. Brown's doing what the Japanese did in between 1990 and 2004 – throwing money at the public sector. The trouble is that public-sector projects do not put the money in the right areas. New infrastructure creates jobs for the length of the project. The long-term wealth creation is negligible. That said, it is a better plan than the German notions of financial austerity. Eventually, the crippling of their own economies will create political unrest in the majority of Europe. So, after surpassing the pound in value, the euro will finish the year 20 per cent lower than its curent value against both dollar and sterling. But the euro is a buy until at least the summer.

OIL

The big see-saw. We see now that there never was any extra demand from India and China – certainly not enough to justify the extraordinary highs we saw last summer. That said, I see oil trading between $28 and $75 per barrel for the rest of the year. A price of $50 per barrel for the year end is as good a bet as any in my view.

SHOCK TO THE SYSTEM

As I wrote in the preface to the original print run of A Fool And His Money, I felt, even back in 1995, that we were entering a new era of super-terrorism. The theoretical example I used at the time was of an impoverished Russian army office selling a mobile nuclear device for a few thousand dollars and a limitless supply of Big Macs. That type of threat broadly described as nuclear proliferation on a micro scale (there are huge numbers of missiles that can be driven around on a truck) – is truly terrifying. If a whole city is destroyed (it would not be London, but it might be one of the less well-surveyed European cities), then all bets are off. Of all the predictions I have made, I really hope this one never, ever comes true.



- Martin Baker is a journalist, author and commentator on international business affairs