In the short term, the question which is attracting most discussion among asset allocators is whether markets are overvalued and whether they are setting themselves up for a 1987-style crash.

Our view would be that, at present, the US, Hong Kong and some of the European markets are significantly overvalued. To put this in perspective the level of overvaluation in the US is, on our models, only about half that of the market prior to the 1987 crash. We are in a small 'bubble'. These are irrational by definition so it is probably fruitless to speculate when it will pop, but that is the likely outcome. At this time however the probable correction is unlikely to be sufficiently large to justify a significant restructuring of portfolios now - of course if markets rose another 15-20% one would have to review this.

A more significant question is what markets will offer the best prospects after the correction or, to put it an-other way, if one is accumulating cash at the moment, what will one buy when the time is right?

The answer will obviously be affected by the extent to which different mar-kets fall, but the area which will be prob-ably the most attractive will be Europe.

The US market is not only materially overvalued now but is approaching the end of its economic cycle. Unemployment is below 5% and wage pressures will increase - the surprise is that they have not become evident already. The Fed will be forced to slow the economy and profits will fall. Overall the US is unlikely to be an attractive candidate.

The UK is in a similar cyclical position: The economy is growing too fast - especially since the Budget failed to slow the consumer; interest rates are rising; and policy will be restrictive which usually prevents strongly rising markets.

At some point restructuring will rejuvenate Japanese industry and lead to a significant increase in profits. Until then it is essentially a market for opportunists and traders. Buying on the periodic sell-offs can provide bargains. It is possible that it will be a candidate for purchase when the dust settles.

The Pacific region can be split into two: the overheated China-linked markets of Hong Kong and Taiwan and the South East Asian markets. The former are in a bubble and may take a while to recover from the after effects, though the long term case is good. The latter have structural problems.

This leaves Europe-and selected emerging markets-as the most probable areas for investment after a correction. Europe is early in its cycle. The economies of Germany and France are only beginning to gain momentum, in contrast to the UK which has been recovering since 1993. In addition to the cyclical factors there are two long term structural changes going on: Firstly, a shift in business attitudes and a more focused pursuit of 'shareholder value' and, secondly, the beginning of an 'equity culture' with signs of increasing personal sector purchases of equities. In the UK these changes occurred in the 1980s and led to a significant Bull market. Short term Europe may be overvalued, but it will probably be the best area to buy after a setback.

Rupert Carnegie is executive director investment research & strategy at Henderson Investors in London.

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