Closing Bell: Theme for year is volatility

This is a notoriously dangerous game, and all too often what seemed to make perfect sense at the time can come back to haunt only months later. However, I think it is also part of the job to at least offer some pointers as to what investors might have to reckon with in the coming year.

Looking back a year, the predictions I offered in this column included more bank bad debts, static interest rates, rising unemployment, a slip in house prices and the UK general election result to offer up a surprise. I think the view on interest rates was fairly obvious, though many others were firmly predicting spiralling inflation and a significant move upwards in the cost of borrowing.

In terms of investment opportunities, I suggested that China and Latin America would produce significant returns and neither has disappointed, although the former is showing signs of moderating. This is a dynamic that will affect all investment markets.

I also suggested that there was enduring value to be found in corporate debt, and again the total returns generated have been good.

So much for looking back. What are the likely threats and opportunities for investors to look out for over the coming months?

It would be fair to say that nobody knows what markets might do next. There are widely divergent views on whether the major economies will continue on the road to recovery, or whether the austerity measures in our own country might lead to a slump in consumer confidence and spending.

Our European neighbours clearly have major debt issues, and those denied the option of devaluing their currency are likely to struggle for quite some time. In fact, it is possible that in the coming year we will witness sovereign debt defaults. Such a prospect merely serves to underline the fact that corporate debt is often less risky than government borrowing. Would you rather lend money to the Spanish government or to Telefonica?

The key factor in determining investment choices in 2011 will be inflation. The price of such essentials as petrol, heating oil and clothing is significantly increasing and hence inflation in the UK remains consistently above the Bank of England's desired cap of 2 per cent.

Given that the current base rate of 0.5 per cent will not rise in the coming year, deposit holders are guaranteed to suffer a loss in the real value of their savings. Consequently, remaining in cash is not a viable option for most, especially if it is being used to generate income.

An inflationary environment favours equities, and certainly there is currently something of a bull market phase under way in most major markets. This can largely be attributed to companies having deleveraged, begun trading profitably and started rewarding shareholders. It is worth remembering, however, that stock markets are also being driven by the quantitative easing programmes that have seen massive quantities of cash printed. Traditional lending practices are still not functioning as they should, either to businesses or individuals. Instead, we see rises in both commodity prices and stock markets.

I believe the coming year will provide plenty in terms of volatility and shocks. It was frightening how, throughout the summer months this year, some were beginning to believe that the European debt crisis had already been played out and had gone away, only for it to return with a vengeance. There is more to play out here, for certain.

While it is probable that equity investors will enjoy further gains, vigilance will be absolutely essential. The degree of volatility is likely to increase, so sensible diversification and a disciplined approach to taking profits will bring rewards. Investors who remain responsive to change should do well in such a climate.

In closing, I wish all readers many happy returns from the challenges that lie ahead.

Ken Taylor is managing director of Mackenzie Taylor Wealth Management. www.mtwm.co.uk

Closing Bell: Theme for year is volatility - but you can make money