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As the year wraps up what lessons can we learn from our trading adventures? Russ Mould readies himself for an uncertain future

A year that began with index rises fuelled by rampant merger and acquisition activity, a robust global economy, moderate inflation and hopes for interest rate cuts has ended on a very different note. The summer’s credit crunch snuffed out several high-profile deals and although interest rates are falling in the US and UK, they are doing so because the world’s central bankers are more frightened of recession than they are inflation, even if food and energy prices are still rising.

The FTSE All-Share has struggled to scrape up a 3.3% increase for 2007, and is still down by 5% from its June high of 3,479. It has not all been bad news. FTSE 100 firms such as Gallaher, Hanson, ICI (ICI), Corus and Reuters (RTR) all fell to bids from overseas, emerging markets such as Brazil tore to new all-time highs during summer and interest rates began to fall in the US and UK in September and December respectively. Mining, Basic Materials and Oil & Gas were sectors which did consistently well through the year.

But this was the year when a pair of high-profile bids for Sainsbury (SBRY) fell apart. The UK also saw its first run on a retail bank for over a century when the credit crisis, which all began with US mortgage firms lending money to so-called ‘sub-prime’ accounts with poor credit histories, swept the world and left British citizens queueing to get their money out of Northern Rock (NRK). The resulting increased reluctance by banks to lend to each other and customers alike has begun to hit the US and UK economies alike. Banks, Real Estate, Construction and consumer-related sectors such as Leisure stocks have been in the doghouse since the summer.

Large caps have easily outperformed small caps, as they tend to be better funded and have a lesser dependence on their domestic economy. The FTSE 100’s 5.3% rise compares to a 12.6% drop from the Small Cap index.

So much for 2007. But what does that tell us of 2008? Shrewdies will have noted the banking stocks on both sides of the Atlantic started to underperform in October 2006, almost nine months before the credit crisis began.

There may be similar clues to be found this time. Mining continued to dominate the performance charts in the fourth quarter, largely because of BHP Billiton’s (BLT) bid for Rio Tinto (RIO).

But metals prices have sagged of late and the sector performance tables reveal Tobacco, Food Producers, Oil & Gas and Utilties were strong performers toward year end. All are classically defensive sectors.

The Federal Reserve and Bank of England are both doing their best to stimulate growth with interest rate cuts. But the recent rotation towards defensives suggests it will take several more cuts before the global economy is back on track.

Investors should therefore position themselves accordingly in stable areas of guaranteed demand, such as utilities, grocery chains and household goods providers. Select mining exposure may be rewarded with a a bid, but those wanting more risk could look to dollar-exposed stocks such as ARM Holdings (ARM) and Rolls-Royce (RR.), as further UK rate cuts could see sterling pull back further against the dollar.

Shares says:

BUY Reckitt Benckiser, Rolls Royce, Sainsbury, Tesco, Unilever

HOLD ARM