An abridged version appeared in the Business Times of 08 Feb 2006

By JOSEPH CHONG

IN OUR internal investment strategy paper for Q1, we predicted that 2006 would be a tricky year for managing money - contrary to the generally optimistic view espoused by most major global investment managers.

Indeed, the various 2005 year-end polls of investment managers are a contrarian indicator. They showed overweight equity and low cash positions.

Recent sharp corrections in various markets and the emergence of geopolitical concerns are beginning to show the trickiness of markets. And we have had to address some interesting questions from our clients:

1) Why does the stock market suddenly fear Iran? The nuclear Iran issue appears to be an archetypal clash of interests between nations. In fact, it could be argued that Iran needs to go nuclear - or at least talk seriously about doing so - if it is to survive in its current form. Why?

Let's look at it from Iran's viewpoint. The armed forces of the US and its allies sit on Iran's eastern and western borders, and the US is not exactly a friend. Having seen how quickly Iraq was polished off, Iran is probably under no illusion about stopping a serious US-led land incursion. Moreover, there is also Israel's nuclear arsenal - some of which is probably permanently assigned to Iranian targets.

Unless the status quo changes, Iran thus lives under the threat of land invasion or a surprise nuclear strike should it decide to assert its foreign policy interests too vigorously. This is essentially a foreign policy at odds with the interests of the West. Having a military nuclear capability would clearly change things - a military invasion or surprise nuclear strike would become unlikely.

Indeed, it could be argued that this is probably the best time for Iran to go nuclear. Oil prices are near-record levels and a war would take Iran's 4.5 million barrels per day off the market. Given the thin demand-supply imbalance of two million barrels per day, the sky would be the limit for oil prices should war break out. The consequences for the economies of the developed nations would be dire.

2) Why is George Soros concerned about the US property market? In the BT Roundtable published on Christmas Eve 2005, I opined that a major risk to the equity markets is an uncontrolled correction in the US property market. This was also the opinion of international investor George Soros when he visited Singapore in early January 2006. Why are we all so concerned?

The problem is not with the property market per se but its impact on US domestic consumption, which is 70 per cent of the US economy and 20 per cent of world GDP. Since 2000, US consumers have been growing their spending far in excess of their incomes. Published studies by the US Federal Reserve have shown that this has been funded primarily by mortgage equity withdrawals - that is, home-owners borrowing more against elevated housing prices.

This overall boost to GDP growth of 1.5-2 per cent, directly and indirectly, is unsustainable because the double-digit rate at which housing prices have climbed is untenable. Conversely, any sharp correction in the housing market is likely to drag US economic growth down severely and could even cause a recession if second-round effects such as corporate cutbacks in employment kick in. The signs are ominous - US Q4 2005 GDP growth slipped to just 1.1 per cent - far below expectations.

A bust in the US housing market would have negative consequences for Asia, especially those economies dependent on US domestic consumption, such as Singapore. It seems like 2007 would not be a good year for elections.

3) What caused the Japanese stock market sell-off? In the BT Roundtable of Christmas Eve 2005, we felt lonely saying sayonara to our overweight equity positions in Japan - we were trimming our client positions there in late December. Everyone else appeared highly bullish. Indeed, the economic news from Japan could not be better: a banking sector expanding for the first time in years, inflation finally positive and corporate ROEs at record levels. The problem is that the stock market discounts the real economy.

In this case, the recovery trends have been apparent for at least a year. The sharp run-up in 2005 caused valuations - not earnings - to expand by about 40 per cent, sucking in hot speculative money. Moreover, the Nikkei 225 appeared to be hitting significant resistance at around the 16,500 level (see accompanying chart). . Livedoor was thus an excuse to sell and not the cause of the sell-off, as market technicians pulled their sell triggers in unison.

The author is CEO of financial adviser New Independent. He welcomes feedback at josephchong@ni.com.sg This article is for information only. Readers should seek independent advice before making any investment decisions.