As is traditional, markets are quiet with very low volumes as we approach the end of the year. This gives us a chance to reflect on where we are, how we got here and where we are going.
Regular market followers might be forgiven for being confused about year-end results, which find the S&P 500 and the DJIA Indexes closing the year flat or in positive territory, and most emerging markets indexes closing the year off by around 20%. In 2011, the global economy has grown by around 3.5%, in large part due to the stellar performances of emerging markets, yet investors have again suffered a dichotomy between fundamentals and performance. For its part, Europe has also suffered heavy losses, a performance that preceded the recession it is now experiencing.
The emerging world has suffered from two primary drags: First, being a victim of its own success (rapid growth led to inflation, requiring more restrictive economic policies, which are negative for equities). Second, moderate improvement of growth dynamics in the US, which also contributed to a shift in flows of investment capital.
Looking ahead for these markets, things are rosier now than of late, with most emerging nations already actively engaged in monetary policy easing, which should reignite growth dynamics, albeit less dramatically than occurred in 2009-10. Importantly, most emerging markets have kept their fiscal policies loose, reflecting a willingness to help rebalance international financial flows. We are positive for emerging market economic growth in 2011. Although our international Emerging Market Investment Committee remains neutral, there are healthy chances that it will upgrade in the first half of the year. Emerging market debt remains an appealing risk-reward asset class.
The performance of the US is less of a surprise to us. Whilst the market has remained trapped in an anachronistic expectations paradigm, with sentiment flipping between excessive optimism and fears of a recession, we have long argued that the US would struggle through with lower than historical growth, much as it did in the previous cycle. This trend is likely to continue in 2012, as fiscal tightening causes financial market stress, but we expect growth to remain positive. There will be scares and volatility, but 2012 may be remembered as the year that the US faced up to its long-term identity challenge, as the Republicans and Democrats square off with contrasting socioeconomic solutions for the longer-term.
Our global Investment Committee is neutral on US equities, in my personal opinion there is downside risk in the near-term, but this asset class is likely to end the coming year flat or positive. (The key risk being historically high margins, and the danger that corporate profits will eventually revert to mean.)
Europe remains the core question for all investors. The potential for stable or positive growth in both EM and the US (as discussed above) is fully dependent on the fate of the Euro Area; particularly on European politicians moving quickly in January to address the recessionary dynamic currently underway. Tough decisions to liberalise markets, sell-off assets and write down Greek debt are necessary. After three grandiose summits, rich on ideas, but followed by an implementation void, the market would do well to stop pre-supposing that Europe will act in its collective interest. Of course, a healthy dose of caution doesn’t mean we won’t see any progress. In 2012, we believe that Europe will eventually get itself onto a more sustainable path.
But, until that happens, we go into the year cautious and preferring short-term trading over longer-term investing.
May the New Year bring you peace and opportunity aplenty.