In the face of tough economic conditions, Royal Bank of Canada (RBC) analysts are advising investors to increase their bond and cash holdings and reduce equities.

"Given deflationary/disinflationary conditions, declining world growth expectations, and a suspect earnings outlook in the US and elsewhere, the investment climate will experience significant changes,'' the analysts stated in the company's latest fourth quarter outlook report. "Key among them is the probable out performance of bonds over equities during the next year or more.'' They recommend investors raise their cash levels to about ten percent and fixed-income holdings to 55 to 65 percent over the next six months to a year.

In RBC's previous report the analysts recommended an allocation strategy of 48 percent fixed-income, 44 percent equities and eight percent cash.

Since then a number of developments have arisen that could restrain the performance of economies and financial markets, the analysts stated. "Many deflationary factors are at work and could last as long as two years or more,'' they stated. "Indeed, outright deflation could threaten substantial sectors of the world economy.'' Among the deflationary factors listed are the economic downturns in emerging economies, International Monetary Fund measures to reduce consumption, high US dollar debt in lower-income countries, and worldwide major production overcapacity.

Throw into the mix slowing world economic growth, slower US growth and profits, the Japan crisis, and Asian banking problems then the financial markets look shaky over the medium term.

However the analysts see positive signs in the longer term. The increasing globalisation of economies and financial markets are likely to create, rather than hinder, investment opportunities.

"We envision a number of global measures,'' the analysts stated. "In the near future, coordinated bailouts and stimulative monetary policies and a network of mutually supportive currency policies should emerge, although greater market crises may be required to prompt urgent action. By reinforcing currency and monetary stability, capital flight can be arrested, in turn providing a more solid framework for economies and markets.'' Until such a framework is built, through some sort of global grouping, uncertainty and volatility will likely continue, they stated.

In the US equity market RBC forecasts flat to negative growth in 1999 but don't anticipate a recession. The analysts recommended an underweight position in US equities of 41 percent.

"A number of factors support this view,'' the analysts stated. "Inflation is expected to continue to fall, inventories are not excessive, consumer spending continues strong, and the fiscal backdrop is conducive to lower bond yields.'' The analysts recommend an equities strategy of 25 percent holdings in European Monetary Union (EMU) countries, 14 percent in the UK, six percent in non-EMU countries, 10 percent in Japan, two percent in Canada, and the rest in Australia, New Zealand and the rest of Asia. In a fixed-income portfolio the analysts recommend holdings of 43 percent in the US, 21 percent in the EMU, 14 percent in non-EMU, ten percent in Japan, nine percent in the UK, and three percent in Canada. The recommendations were made in the bank's International Investment Outlook publication, which The Royal Gazette receives regularly though Royal Trust (Bermuda) Ltd., the bank's subsidiary on the Island.

UPS AND DOWNS -- Chart shows the perspective of several nations' ranking in relation to the business cycle. The chart was developed by evaluating country risk (political and economic), market liquidity and fundamental investment worthiness.