Treading water in the first-half

Stocks and bonds have shifted sideways so far in 2004. So will it be any better in the second half of the year?

Or could things get worse? If so you should be banking cash in a savings account.

Stock and bond prices really don't know which way to jump this year. Bloomberg's survey of 18,000 long-term funds shows an average return of 0.6% this year. iMoneyNet has short-term money funds coming in close behind at 0.5%. This does not seem much of a return for putting your money at risk. Indeed, a humble savings account would offer a similar return for no risk at all. At the Funds World conference in Dubai last week it was clear that the only way to shoot for very high returns in this market is huge levels of gearing. Say for example, you take a hedge fund with four-times leverage and gear it ten-times, then with interest rates so low you can pocket the difference between the magnified gain and the interest payment. It seems odd that some banks are willing to lend money to such a risky enterprise, for that is surely all that this is. They will obviously loose out big-time if this investment goes wrong, and the investor will loose his or her shirt. Taking huge risks is always a way to make huge profits, but also a way to loose your entire capital very quickly. It will be interesting to note the performance of such hedge funds in an unexpected market downturn. That leads us to consider the markets themselves, which appear to be in a 'state of denial'. What does this mean? Higher interest rates - which are bad for bond prices and equities - are starring the markets in the face. We have the officials of the Federal Reserve hinting strongly some days and less strongly on other days. For the twin deficits of the US economy can not continue for much longer, and for the economy to rebalance, without a big hike in inflation or a massive depreciation of the currency, then interest rates just have to go up. As the linchpin of the global economy whatever happens in the US has huge implications for every other capital market in the world. Oil is the factor that threatens to upset this 'state of denial'. A sudden spike in oil prices would tip capital markets into reverse before interest rates rise by very much. Otherwise, the Fed officials can probably put back the evil day until after the US presidential election. For investors this means a strong cash position is the obvious course of action. In a recession 'cash is king' and that is most likely where the global economy is heading next. All periods of high oil prices have always been followed by a recession, and betting against history is almost the definition of a 'state of denial'.