Philadelphia-based Brandywine Global Investment Management manages $13 billion in global equities. Safa Muhtaseb is a portfolio manager who recently toured Asia.

What has been the biggest surprise in the past year?
Safa Muhtaseb: Our biggest surprise in the past 12 months has been bond yields, which we thought would go down. We paid too much attention to the forces of globalisation and the abundance of liquidity, and not enough to the impact of higher commodity and energy prices and the ripple impact they had on products and services.

Is inflation a problem?
Inflation is still a concern. ItÆs starting to appear in the global economy, thanks to the impact of energy and commodity prices, plus the activity of the Federal Reserve and other central banks. [Fed chairman Benjamin] Bernanke is taking the right stance. The FedÆs unsure of its next move and needs to tread carefully. BernankeÆs transmitted that message but itÆs not the one the market wanted to hear.

Did Bernanke trigger the sell-off in May?
The main cause of the correction wasnÆt what he said. The world woke up one morning with significantly higher expectations regarding inflation. WeÆve had three years of growth in corporate earnings and investors became concerned this will stop. Consider this: from March 2003 to March 2006, in US dollar terms, the MSCI EAFE [Europe, Africa and Far East] index rose a cumulative 140%. The MSCI Emerging Markets Free rose 200%. Even US equities were up 50%.

What explains those three years of terrific gains?
Companies experienced a recovery in earnings growth following the end of binge spending and the TMT bubble in early 2000. They focused on their core businesses, on efficiency, on generating cash. They restructured, laid off people and shifted production, and this resulted in improvements in profitability.

How good was earnings growth?
Consensus for S&P 500 company earnings growth in 2005 is 13.7%, and itÆs 22% for Europe and 42% for emerging markets. ThatÆs on top of similar gains in 2004. In addition to corporate recovery, we had a wave of liquidity from oil-producing nations, from emerging markets building account surpluses, and from Japanese investors seeking yield. All of this fuelled stock markets around the world.

Is this story over?
IÆd say the recovery of corporate earnings is slowing down. Liquidity isnÆt as abundant. JapanÆs ended its quantitative easing policy and is expected to tighten monetary policy. The Fed just announced its 17th consecutive quarterly interest rate rise. The European Central Bank has begun to tighten rates. (Editor's remark: Since this interview the BOJ has raised its key rate by 25 basis points)

What does this imply for economic drivers like American consumers?
Consumption still accounts for 70% of US GDP. While many economists note that Asia is less dependent upon exports, Asia is not independent of exports. If US consumption slows, the whole world feels it. To an extent, this would be welcome, given the disparity between AmericansÆ spending and income, which has been financed by a housing market during a period of falling interest rates. That market is now cooling off.

Does this spell trouble?
IÆm not a pessimist. Job and income growth in the US are healthy, and the housing market isnÆt going to crash. And we also see consumption picking up in Japan, Asia and even Europe. But these factors wonÆt be enough to completely offset the effects of a slowdown in US consumption.

Is this reflected now in stock prices?
The macro issues are baked into market valuations. Consensus expectations for earnings growth this year are 12.9% for the US, 11.1% in Europe, 7.7% in Japan and 16.5% in emerging markets. These expectations arenÆt too demanding, and the valuations we see today are attractive. Forward-earnings estimates for the S&P 500 are 14.7x. Unless the US unexpectedly spins into recession, the world isnÆt doing badly. WeÆre moving from three years of fast growth to a more sustainable phase along trend lines.

Where is value to be found?
ThereÆs value in equities globally.

Where is value fading?
Some economies are cyclical, like Germany and Japan, and they are likely to slow. Industrials like Caterpillar and Komatsu have enjoyed multiple years of top- and bottom-line growth, thanks to all this construction around the world; their valuations may not seem rich but theyÆre based on peak earnings.

What sectors are attractive?
Stable growth companies in food and beverages, tobacco, pharmaceuticals, retail. These valuations are compelling, and their growth prospects are reasonable. ThereÆs a greater probability of an upside surprise.

Are valuations the key indicator?
TheyÆre not the only indicator. Energy stocks today are trading at 9.2x on average, while healthcare stocks in the US are trading at 15.3x. But energy companies are at that multiple after enjoying earnings growth of 45% in 2005, following similar gains in 2004. Healthcare companies in the meantime have had depressed earnings and investors have limited expectations; theyÆve been crushed. But a lot of these companies are very profitable. Margins can be 30-35%. TheyÆre engaging in share buybacks and are looking to buy growth. Johnson & Johnson recently paid $16.6 billion in cash for PfizerÆs consumer business, and instantly doubled its market share.
Some parts of the IT industry also look attractive. The sector is trading at 18.9x on depressed earnings. We like the networking equipment area. Competition among the telecom and cable guys is helping the Ciscos and Nortels of the world.

How would you describe your portfolio overall?
WeÆve tilted toward companies that can grow, are cheaper than their historical averages, and have dominant franchises that donÆt deserve to be so cheap. WeÆve been adding names like Anheuser Busch, Barclays Bank, Cisco, J&J and Sanofi Advantus.