Quarterly Investment Outlook Q1 2007 from F&C Asset Management

Quarterly Investment Outlook Q1 2007 from F&C Asset Management plc

Buying back Equities

In terms of our asset allocation strategy, we have closed our underweight position in equities and we are more constructive in our outlook. The market appears much more comfortable with a low growth, low inflation and low interest rate environment. Better than expected economic data in Europe and in the emerging market countries provides a supportive backdrop to buy back equities.

With emerging market equities historically a beneficiary of a weak US dollar, we have reduced the underweight position in this asset class and now hold a neutral stance.

Japan Steadies Ahead of a Brighter 2007

We have maintained our overweight position in Japan. Despite a mid-year dip in 2006, the Japanese market has made impressive gains over the two year period to the end of December. The features that reignited interest in the Japanese market remain in place – including the emergence from an extended period of deflation and strengthening corporate earnings.

Also significant are a number of secular growth themes that will have lasting impacts on the Japanese economy.

Hindsight Review Q4 2006

The fourth quarter of 2006 saw global equities rally as corporate earnings and ongoing merger and acquisition (M& A) activity continued to support markets. Lower oil prices and easing global inflationary concerns also boosted markets despite the continued deterioration in the US housing market.

The oil price declined during the period to slightly below $62 a barrel. Crude oil slipped after warmer-than-usual weather in eastern US curbed demand for heating oil by the world's top energy consumer. A fall in oil prices dragged down energy shares.

In the US, equity markets gave up some of their early gains during the quarter which saw the S& P 500 index climb to a six-year high. The Federal Reserve's (Fed) decision in December to leave interest rates unchanged at 5.25%, as well as encouraging readings on retail prices helped underpin the market's rally. In particular, headline and core consumer prices were both unchanged in November. Furthermore, a strong corporate environment, characterised by robust earnings results and solid M& A activity, also helped to support the market. However, economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market while investors took profits towards the end of the period, mainly in the technology sector. The US dollar weakened against the euro and the yen as investors continued to price in rate cuts by the Fed in 2007.

In the Eurozone, a combination of robust economic growth and a strong corporate environment saw continental European equities rally during the period. To contain underlying inflation pressures, the European Central Bank (ECB) raised interest rates in October and December to 3.5%. The German Ifo business sentiment survey surged in December to its best level since reunification as firms' business expectations and their assessment of current conditions both improved. The euro approached a record high against the yen and rose versus the dollar after the strong Ifo reading, reinforcing expectations for an ECB rate hike next year. In the UK, the equity market was supported by domestic economic growth and ongoin g M& A activity. Inflation remained above the Bank of England's target rate triggering the Bank to increase interest rates by 25 basis points to 5.0%.

The Japanese equity market fared better during the fourth quarter despite speculation of a rate rise in Japan. The Bank of Japan (BoJ) left its key interest rate unchanged at 0.25 % although evidence of economic growth exceeded expectations. The BoJ cited falling consumer demand as the reason for maintaining rates while indicating they believe the economy could handle a gradual increase in rates during 2007. While business investment continued to support market valuations, exports were also one of the main drivers of the Japanese economic recovery. From a sector perspective, investors moved towards defensive sectors with utilities and healthcare improvin g considerably over the quarter.

Elsewhere, a steep fall in the Thai market pulled Asian markets lower. Thai equities fell as foreign investors took fright after the government imposed capital controls to rein in a soaring baht currency but recovered soon after.

M& A remained a key feature of global equity markets. In the US, The pharmacy benefits manager, Express Scripts offered to buy rival Caremark. This offer threatened to disrupt a deal brokered with drugstore chain, CVS Corp. Meanwhile, UK mobile phone group, Vodafone sold its 25% stake in Swisscom Mobile. In Europe, Norway's Norsk Hydro, the energy and aluminium group and Statoil agreed to merge the two groups' oil and gas activities.

Global bond markets experienced a volatile period. After solid performance in October and November, investors took profits in December before the quiet trading period over year-end. However, the US Treasury market rose, particularly the long end of the yield curve, as slowing economic growth fuelled investor sentiment. Expectations rose over the quarter that the Fed may reduce interest rates in 2007 in order to support economic growth. Euro government bonds were volatile, held back by robust economic data in the euro area and two interest rate hikes by the ECB. In the UK, the interest rate increase by 25 basis points was expected as inflation rose above the Bank of England's target rate of 2%. UK gilts also suffered amid investors' fear that the Bank might raise interest rates again in the first half of 2007.