The rise of the middle class in China is significant, particularly at a time when the US, Europe and the UK are experiencing a consumer slowdown: demand from affluent consumers in developing nations could provide some support for companies whose established customer base is feeling the pinch. However, soaring food prices are having a negative effect on China’s people, many of whom have become accustomed to a relatively comfortable existence over the last few years. China’s agricultural capacity and processes have not kept pace with its urban and industrial expansion and, although incomes have grown significantly, food prices are now rising faster than wages.

Will China go unchallenged as a global economic force of the future? Perhaps not. For now, China remains the most populous country in the world with 1.3 billion people, closely followed by India, which has a population of 1.1 billion, and whose booming economy has also been the focus of much attention. Looking ahead, the government’s official “one-family, one child” policy is likely to mean that China’s population begins to plateau over the next few decades, while India’s population is expected to increase.

China’s development has influenced almost every area of the global economy. Strong demand from other nations for its cheaply manufactured products has helped the economy expand rapidly; however, this vibrant economic growth has had its downside, and the Chinese government has sought to cool down the country’s export-fuelled growth. Meanwhile, inflation continues to run at very high levels, stoked by surging food prices, and the country’s insatiable appetite for raw materials and oil, driven by the rapid development of its infrastructure and booming demand for its exports, has helped to stoke surging commodity prices. Ultimately, in common with the rest of Asia, China is unlikely to prove immune to the full effects of a US-led slowdown, and this could help to put a brake on China’s growth in the short term.

Sovereign wealth funds are government-controlled investment funds, created when countries with surplus cash elect to invest some of that money. Most of the significant sovereign wealth funds are owned by the governments of booming Asian countries, such as China, or oil-rich countries such as Kuwait or Norway. Their substantial assets under management mean that, when they buy shares in a company, their stake tends to be sizeable.

Sovereign wealth funds hit the headlines initially last year as investment banks took their investments as support in the outbreak of the credit crisis. More recently, a Chinese fund has accrued a stake of almost 1% in UK oil giant BP, following the acquisition of an already significant stake in French oil company Total. Some market watchers have become concerned about the motives behind these purchases; China needs to have oil in order to fuel its ongoing expansion, and some commentators have flagged the possibility that China might be building stakes in major oil companies in order to gain influence within the sector.

Most of these funds tend to be secretive, a factor that has fuelled these questions about motivation. Many detractors are concerned about the possibility that an underlying government might actually aim to interfere in the running of a company in which they are invested. In addition, accusations of speculative activity have been levelled against some managers. However, defendants of the funds argue that the managers are just looking for long-term, stable returns like any other investor.

Although sovereign wealth funds have hit the headlines relatively recently, they are hardly the new kids on the block. Indeed, some have been around for a long time; for example, the Kuwait Investment Authority was founded more than fifty years ago in 1953.

Looking ahead, there are moves afoot to persuade sovereign wealth funds to sign up to a code of conduct that would ensure greater disclosure about their assets and investment strategy. It is unlikely that all the governments involved would be willing to accede to such an agreement; however, until sovereign wealth funds become more open about their investment activity, their detractors are likely to remain critical.

However, the boot is now on the other foot. Since the credit crunch took hold last year, it has become increasingly difficult and expensive to borrow; banks and building societies have tightened their lending criteria and raised their rates, and the availability of mortgages has contracted sharply.

In its recent Credit Conditions Survey, the Bank of England has warned not only of a decline in the availability of mortgages, but also of a likely increase in the proportion of defaults by struggling homeowners. The heightened risk that some borrowers might default on their mortgage payments has spurred many lenders to make their lending criteria more restrictive, reducing the opportunity for higher-risk applicants to borrow money.

Meanwhile, new mortgage approvals declined from 74,000 to 73,000 during February, a drop that took the figures close to their 13-year low. Steepening mortgage rates are deterring potential first-time buyers from entering the housing market. However, demand is still relatively high in certain areas – the fixed-rate deals of over a million borrowers will expire this year, forcing them to look for new deals. Meanwhile, following the collapse of Northern Rock and its subsequent nationalisation, many of its customers are looking to move their mortgages to an alternative lender.

Several lenders have reduced access to their mortgages; and attractive deals have become increasingly rare, so any company offering competitive rates has been swamped with potential customers. First Direct has temporarily stopped offering mortgages to new customers while it catches up with the paperwork, and Abbey has now withdrawn the last straightforward 100% deal ‘in order to maintain high service levels’.

The Bank of England has cut interest rates to 5.5%, and rates are widely expected to fall further over coming months. Despite this, many lenders have actually raised their mortgage rates; the global credit crunch has deterred banks and building societies from lending to one another, so the companies are working to protect their profit margins. In the long term, banks and building societies are likely to regard the current situation as an opportunity to clean up their lending books and emerge in better shape; in the immediate future, both borrowers and lenders are likely to feel the pain.

Nevertheless, investors remain nervous and the Fed has been criticised for what some economists view as a short-term approach to the deeper-seated problem. The economic outlook continues to deteriorate following the collapse of the domestic housing market, the global credit crunch, and soaring fuel prices.

US interest rates have now undergone six cuts since September 2007 – so where do we go from here? The Fed has cut its forecast for economic growth in the US and appears to anticipate a greater-than-expected rise in unemployment over the course of 2008. Meanwhile, inflation is forecast to reach as high as 2.4% in 2008, driven by surging prices. The current scenario has raised the unwelcome spectre of stagflation, in which prices continue to rise while growth stagnates.

Despite the risks to inflation, the deteriorating environment had boosted expectations of interest-rate cuts in 2008, and Fed chairman Ben Bernanke has favoured monetary easing to stave off a recession in the US and ease the effects of the credit crunch. Lower interest rates in the US will have a direct influence on the global economy: the US economy is still the largest in the world and an economic slowdown in the US would have a negative effect on economic growth in many countries in Europe and Asia, where exports to the US can make up a significant proportion of revenue.

Any recovery in US demand would be well received, but lower interest rates do undermine the already weak US dollar, providing additional impetus for the booming oil price, which could stoke inflationary pressures. Where the Fed now goes from here remains to be seen, but policymakers are having to perform a delicate balancing act in trying to ensure the economy does not stall, at the same time as keeping inflation in check.

Growing fears of a recession in the US have led policymakers to reduce US interest rates in order to stimulate economic growth. However, these lower interest rates could help to stoke inflation and exacerbate the decline of the faltering US dollar. A weak dollar helps to drive the gold price higher: like oil, gold is priced in US dollars, so dollar weakness makes gold cheaper for investors buying in other currencies.

The effects of increased demand for gold have been compounded by a growing shortage of supply. Electrical power cuts have halted production at some of South Africa’s most important mines when the South African government was forced to take the radical decision to ration electrical power. This, combined with fears that gold production could be halted for several weeks, helped to boost gold prices to their recent highs.

A good diversifier

Volatile market conditions, coupled with the fallout from the global credit crunch and growing fears over prospects for the global economy, have led many investors to add gold to their investment portfolios. However, gold does not have to be viewed purely as a safe haven; for many investors, it has become an important, long-term element within a diversified investment portfolio. It is vital to acknowledge that gold is not a risk-free investment: its price is volatile and can fluctuate rapidly. Nevertheless, gold’s low correlation with the equity market and bond market make it a useful means of diversification within an investment portfolio.

Some investors favour owning gold directly, which can be bought in the shape of gold coins and bullion bars; others prefer to gain exposure via exchange-traded funds: investment funds that track the price of gold. A lower-risk approach – in relative terms – might be to opt for a diversified commodities or natural resources fund, thereby spreading an investment over a wider area than just gold.

Looking ahead, investor sentiment is likely to remain fragile and bad news will likely meet with a disproportionate level of disappointment. Investors have good reason to be wary in the short term; however, stock markets tend to be driven not by logic, but by emotional factors such as fear: the key is to stay calm, think long term, and be selective. Astute long-term investors should remain objective and remember that, in the words of Franklin D Roosevelt, “the only thing we have to fear is fear itself”.

However, statistics released by the Office of National Statistics last month show that the proportion of married couple families has decreased in the past 10 years from 76 per cent to 71 per cent. There are now more than four million families where the parents are either single parents or cohabiting. If they own a house worth above £300,000, their heirs will potentially face an inheritance tax bill.

Likewise, siblings and carers will still face tax bills if the home they have shared and subsequently inherited is worth more than £300,000. 

Lloyds TSB concluded that the sale of Abbey Life was in the “best interest of the group, as well as Abbey Life’s policyholders and staff”.

As of 31 December 2006, Abbey Life managed £12bn of assets held in 1.2 million policies, do you own one of the policies? It will be interesting to see what if any benefit there will be for policyholders. If you would like us to review your Abbey Life plan in view of this announcement then please contact us.