What is your resolution for the New Year? Spend less, save more and invest prudently?

But invest where? Not an easy question to answer. However, a broad outline of what one should expect in the coming year can be sketched from the shadows of 2006.

Global influence

During the last couple of years, the central banks of almost all countries, including the Reserve Bank of India, tightened their monetary policies to curb inflation and excessive growth in personal loans and consumption.

As a result, an economic slowdown has begun in the US and Europe. Economic growth in the US has declined from 4.2 per cent in the third quarter of 2005 to 1.6 per cent in the third quarter of 2006.

A sluggish US economy implies lower growth for India’s exports as the US accounts for more than 20 per cent of India’s overall exports. India’s exports to countries that have large exports to the US and European Union countries could also be affected.

A retardation in exports could slow down economic growth back home. The result: domestic stock markets that gave a 44 per cent return in 2006 may not be able to repeat the performance in 2007.

However, a slowdown in the US and European Union countries may prompt the central banks there to relax their tight monetary policies by lowering the rate of interest. If this happens, investments in those countries will become more lucrative, resulting in a slowdown in foreign direct investments in India.

Back home

On the domestic front, the increases in interest rates and a hike in banks’ cash reserve ratio by the RBI are expected to cool down the country’s growth by raising the cost of borrowing.

The rapid economic growth of the country between 2000 and 2004 was largely driven by high growth in domestic consumption following cheap and easy availability of retail and personal loans. The growth in housing loans, credit cards and consumer loans stoked the 8 per cent GDP growth and profitability of companies.

A tighter liquidity situation and higher interest rates will now dampen the credit-based demand growth, and hence corporate profitability, at least for the next two quarters.

This means the return on investments from stocks and real estate will not be as high in 2007 as it was in 2006.

Reasonable returns

Corporate profitability in 2007 will also depend largely on the realisation of the excess capacity they have created over the last two years through expansion. Slowdown in demand growth, both global and domestic, may see returns from stocks coming down to a reasonable level of 20-25 per cent.

M&A money

Last year, companies had large cash flows due to surging global and domestic markets. They will be more interested in using these reserves for acquisitions and mergers. The merger and acquisition space, which had been vibrant last year, is expected to remain equally vibrant, if not more.

Mid and small caps

If 2006 had been a year for large-cap stocks, 2007 will be for small and mid-cap stocks.

The rally in sensex in 2006 had two parts — one between January 1 and May 10 and the other between June 14 and December 29.

A close look reveals that stocks across the spectrum appreciated during the first part of the rally. In the second leg, mostly large-cap stocks gained in value, primarily on sustained buying by foreign institutional investors. Small- and mid-cap stocks remained largely untouched till November. In the last two months, these stocks have seen some steady buying interest.

On the days the sensex declined in December, the fall in BSE midcap and smallcap indices vis-à-vis the sensex was less.

Rajesh Sehgal, a fund manager with the Emerging Markets Group of Franklin Templeton Investments, said, “The BSE sensex has returned an impressive 168 per cent over the last three years. The BSE midcap index during the same period has given an even more impressive return of 215 per cent. With the market valuation looking over-stretched, small- and mid-cap stocks with sound fundamentals, which have not participated in the previous rally, are now available at a reasonable price.”

Mutual funds

Savvy investors can consider exchange-traded funds (ETFs), which are becoming favourites across the globe. ETFs represent a portfolio of stocks designed to track one specific index, say the sensex. Shares of an ETF can be bought and sold on stock markets just like any other stock.

ETFs thus give investors the opportunity to buy or sell an entire portfolio of stocks in a single security. ETFs give the same return as the index.

Cool commodities

The commodity market will continue to do well in 2007. According to JP Morgan Chase, a leading investment banker in the US, gold will continue to attract investors’ interest. “In the face of a depreciating dollar against most of the global currencies, investors will prefer to hold gold to hedge their investments,” it said.

Among other commodities, metals are expected to fare well in 2007. “The average cycle in metal prices lasts for seven to eight years. We are only five years into the current upswing in metal prices,” said an analyst with a commodity brokerage.

Fixed income

Among fixed income assets, bank fixed deposits — particularly short- to medium-term ones — will become more lucrative. Banks are already offering 8 per cent interest on deposits maturing between one and two years.

Personal tax

Investors, however, may expect some significant developments on the personal taxation front. Finance minister P. Chidambaram may introduce the exempt-exempt-tax system (EET) in 2007-08 budget. The committee set up to study the feasibility of implementing the EET system submitted its report in November 2005.