Controversial German politics, inflation ruffle global financial feathers this month

All markets offered positive gains in October, but with marked differences. Whereas US markets were nominally positive, Eu-ropean markets fared much better. The UK rose by nearly 3 percent, Germany and France by around 4 percent. Asian markets rose even more dramati-cally. Japan continued its rapid improvement by posting an 8.5 percent gain, and both India and Korea rose by around 10 percent.

After a decisive election in Japan that produced a clear mandate for reform, the contrast for Ger-many could not have been starker. Angela Merkel's CDU/CSU coalition enjoyed a clear advantage over Schroeder's SPD/Green coalition heading into September's election. But by the end of the polling day, the two parties were separated by less than 1 percent, with Merkel just scraping a majority.

A period of political confusion ensued. Schro-eder was unwilling to let go of what had been a remarkable election comeback. Merkel had a poor campaign but her coalition won four seats more than Schroeder's in Germany's parliament, so she wasn.t about to quit either. There was concern that political in.ghting and egos would combine to keep Germany in a state of drift. Constitutional procedure means that the impasse could have lasted into November, by which time a failure to reach agreement would have required fresh elections. The euro suffered as a result but climbed again at the end of September alongside hopes for a grand coalition.

The worst scenarios were avoided as Schro-eder's Social Democrats .nally conceded the Chancellorship on October 10th. Nevertheless, the agreement saw the Social Democrats win control of eight of the key government ministries, includ-ing foreign affairs, employment and finance. The grand coalition agreed between Merkel's Christian Democrats and Schroeder's Social Democrats has dealt Merkel a weak hand, putting a question mark beside the promised economic reforms that formed a key element in her election package. The euro dropped mid-October following doubts over Merkel's ability to carry out employment reforms. European economic research group Ifo Institute's business climate poll rose for Germany to 98.7 in October from 96.0 in September, sparking a mild recovery for the euro in late October.

Figures from almost all major economies suggest that inflationary pressures are becom-ing more evident. For Japan, this is a positive, after a prolonged period of crippling de.ation. De.ation encourages people to delay purchases as goods will become cheaper, and money held in the bank . even when interest rates are near zero . increases in real terms. It also discour-ages people from borrowing to invest as the real value of the debt increases over time. Analysts now expect inflation to turn positive in Japan by the end of this year. If this is maintained, it should continue to encourage improved levels of domestic spending which is a vital component if Japan's recovery is to continue.

In Europe, inflation rose to 2.5 percent, which is well in excess of the ECB's target of 2 percent. In the UK, inflation is expected to rise to 2.8 percent, and in the US consumer price inflation is expected to rise above 4 percent. With oil prices expected to remain high for some time (the IMF forecasts that oil prices will average $61.75 per barrel over the next five years) and with central banks remaining hawkish about the dangers of inflation (the Federal Reserve once again raised US interest rates, citing inflationary concerns) there will be little room for rate cuts should major economies stumble, and especially if housing markets start to fall.

Stock pick of the month

This month's pick is Alcoa Inc. (NYSE: AA). Alcoa is the biggest aluminum company in the world. It is vertically integrated and consumes a great deal of the resources it mines and smelts. Alcoa's development of a number of value-added products (most notably, for use in the aerospace industry), in conjunction with excellent margins, mean that it is well able to successfully compete against the low-cost alumi-num producers that are emerging in developing nations. Meanwhile, Alcoa also confronts these low-cost challengers in their own home markets by purchasing interests in mines and smelting factories around the world.

Alcoa's financial ratios suggest that the stock is considerably undervalued, with a Price/Book ratio of only 1.50, a Price/Cash Flow ratio of 9.10 and a Price/Sales ratio of 0.80. The company's Return on Equity and net pro.t margins are both very high for the industry. It is a well-known company with a solid history and a healthy 2.5 percent dividend, and the stock is trading near its 52-week low. Although its share price re.ects some tough times, a new management team is turning things around. Moreover, despite weath-ering difficulties in the recent past, the company is in excellent financial shape with Total Debt/Equity at 0.52 and $457 million in cash.

Tenbridge Asset Management added Alcoa to its portfolio in July of this year. The stock has been volatile, rising and falling by more than 10 percent over the last 3 months. We believe that surging energy costs and concerns over a slowdown in commodities have depressed the share price to a level at which a -rate company is available at a great price. Accordingly, Alcoa is one of the most heavily weighted stocks in our US portfolio.

Justin Lowes is Chairman of Tenbridge Consulting www.tenbridge.com, an independent financial advisory firm based in Beijing.