Although risks remain and volatility will continue, Andreas Utermann is more positive about the world in 2013 than at any point since 2007. US growth could surprise on the upside and markets could see the beginning of the end of the great financial crisis.
Economic Outlook and the Eurozone
What We Predicted for 2012:
We do not expect most developed economies to fall into recession, and we expect emerging-markets growth to remain solid. However, growth risks are increasing—particularly in Europe where a recession in the core euro-zone economies is now almost certain. Our medium-term outlook remains unchanged: in times of high public-sector debts, and private- and public-sector deleveraging, trend growth will be lower than before the bubble burst. This period is likely to last for several years.
Our Current View:
While remaining positive, global growth did remain below trend again, as expected, in 2012. This was primarily driven by a sharp growth slowdown in Japan, a continued near-recessionary environment in Europe, slowing emerging-market growth and a continued below-par recovery in the United States. The key macroeconomic factors contributing to this continue to be excessive private-sector debt in many economies, rising public-sector debt in almost all economies, the continued stressed bank financial sector in Europe and the political problems surrounding the eurozone.
Owing to the decisive action by the European Central Bank (ECB) in the summer of 2012, followed by a reinvigorated political process in Europe, it is possible to envision a more benign middle-term scenario for the eurozone for the first time in a number of years. While growth is still expected to remain in near-recessionary territory for most of 2013, there are tentative signs of green shoots in the eurozone periphery, notably the elimination of current account deficits and Greece remaining in the euro zone. Encouragingly, Ireland—the first country to receive a euro-zone bailout—may regain access to capital markets in the course of 2013. Problems remain, though, including elections in Italy and a French program of economic “reforms” that may exacerbate rather than remediate France’s structural problems.
Fears about China’s hard economic landing and political uncertainty have not materialized, and we are likely to see continued robust growth in China in 2013.
Most encouragingly, the United States could surprise on the upside in 2013. This is primarily based on our conviction that the US housing market has turned, and that there is a broad base housing market recovery underway that will increase consumer confidence and also possibly encourage corporations to spend some of their large liquidity surpluses.
Budget Deficits and Central Bank PolicyWhat We Predicted for 2012:
A quick fix is unlikely. Realistic political actions take a long time to be implemented and even longer to be effective—most likely too long for financial markets. The longer the debt crisis looms, the bigger the political risk. As recent developments in Greece show, there is a real threat of a breakup of the eurozone if political processes get out of control. Debt monetization is already on the agenda in the US and the UK but not in the European Monetary Union (EMU), even though the ECB has become more “Fed-like.” Medium-term, we think a more active and aggressive role for the ECB is likely.
Our Current View:
The fiscal situation in most economies has continued to deteriorate in 2012, as expected. As a result of this, central banks have continued with their ultra-loose monetary policies. In many cases—such as in Japan, the US, the eurozone and the UK—those policies have been reconfirmed and reinforced. Most importantly, and as we had hoped, the ECB made a decisive step in the summer of 2012 toward becoming a more credible lender of last resort, which led to a broad-based rally in risk assets in the final part of 2012.
Should growth surprise on the upside in 2013 as expected, the rate of increase of government debt globally should slow. Nevertheless, we predict a continued ultra-loose monetary policy regime for Organization for Economic Co-operation and Development (OECD) economies for 2013 and beyond. This should continue until such time as trend or above-trend economic growth is firmly established.
InflationWhat We Predicted for 2012:
We believe the cyclical moderation will trigger a moderation in inflation rates again. Given the low level of real interest rates, ongoing central bank balance-sheet expansion and our expectations of continued solid growth in Asia, we do not expect a return of deflationary fears, despite weakening growth. On the other hand, with demand for money strong in the current period of deleveraging, inflation is unlikely to be a threat in the foreseeable future.
Our Current View:
As expected, neither inflation nor deflation concerned markets significantly in 2012. For 2013, we do not expect either one to be a major topic of market concern. While global growth remains below trend and private sector debt levels stay elevated, inflation is unlikely to be a major issue while aggressive quantitative easing policies will keep deflation at bay.
Interest Rates and BondsWhat We Predicted for 2012:
We expect rates to come down further in the eurozone and emerging markets. In the US, the UK and Japan, we expect the policy of extremely low interest rates to continue. The downside to bond prices in the UK and US clearly is limited. As long as political uncertainty persists and economic data remain weak, we expect risk aversion to prevail. Bunds are likely to remain 'safe haven' assets for the time being. A “risk-on” trade within the European bond markets is only likely once economic data starts to improve or the ECB takes a more-active role in solving the debt crisis. Longer term, we remain cautious on sovereign bonds at current yields. Even if nominal returns may turn out to be positive, we expect real—inflation-adjusted—returns to be disappointing.
Our Current View:
EMU bond markets continued to be driven by political events in the first half of the year. As predicted, a “risk-on” trade in European peripherals kicked in once the ECB had emphatically stated it was not going to let the EMU fail—statements that were then later confirmed by European policymakers. We expect aggressive quantitative easing policies to continue through 2013 and thus limit the downside; however, with nominal bond yields throughout the yield curve now at record low levels, we do not expect nominal returns to match inflation over the next 10 years. Benchmark bond yields (Japanese government bonds, US Treasuries, German bunds and UK gilts) appear overvalued. For 2013, we continue to favor selective corporate and high-yield issuers, other spread products and, notably, selected emerging market global currency debt.
EquitiesWhat We Predicted for 2012:
With economic activity slowing globally and with moderate equity returns, we prefer stocks with relatively high dividends and payout ratios. Dividend payments should offer investors some protection in the current environment. A lasting rebound in equity markets is expected only if markets can start to price in a credible solution to the EMU debt crisis and/or when economic data point toward a stabilization in economic activity. Political tensions or sovereign debt fears would be another buying opportunity for those who want to establish longer-term positions.
Our Current View:
For the first seven months of 2012, equity markets were very volatile with dividend stocks performing particularly well—as we anticipated. Also as expected, equity markets rebounded following the decisive action by the ECB, with most major equity markets ending the year in double-digit territory. In local currency terms, as of 27th December 2012, German equities had performed best with a near-30% return, followed by Asian markets at around 20% and the S&P 500 at approximately 15%. For 2013, we expect equities to continue to outperform bonds with overall returns in the region of 8%-10% possible. There will be continued volatility and any significant weakness should again be used to establish longer-term positions.
CurrenciesWhat We Predicted for 2012:
Strategically, we will hold on to our expectation of appreciating emerging market currencies due to superior growth and productivity gains. We are waiting for an attractive entry point to re-enter this asset class. We expect some appreciation of the US dollar due to the still-unsolved eurozone debt crisis. In addition, the US dollar looks somewhat undervalued relative to the euro.
Our Current View:
For the major currencies—the euro, the US dollar and sterling—the year brought much volatility but, as expected, no major changes in their relative values. As expected, the renminbi has continued to appreciate against both the US dollar and the euro, and the yen appears to have started its long-anticipated relative decline. For 2013, we expect a very similar picture.
Emerging MarketsWhat We Predicted for 2012:
Emerging markets remain strategically important and the slowdown in economic activity will end, in our opinion, in a soft rather than hard landing. The reasons for our relative optimism are negative real interest rates, a rather low level of total indebtedness and strong underlying demand. Our positive view on emerging markets leads us to a strategically positive view on emerging market assets—whether equities, bonds or currencies.
Our Current View:
Most emerging markets assets have, as expected, outperformed in 2012; in a relatively benign market environment they should continue to perform well in 2013.
ConclusionWhat We Predicted for 2012:
We expect 2012 to be similar to 2011: bouts of risk aversion followed by increases in risk appetite, all against a background of relatively low growth and great political uncertainties in all regions. Countercyclical and long-term–oriented investment behaviour will be imperative for market participants.
Our Current View:
2013 could well be the year when growth in the US surprises on the upside and markets begin to anticipate the beginning of the end of the great financial crisis. Clearly, many risks remain and continued volatility in risk assets is certain to be a defining feature. However, overall we are feeling more positive about the world at the start of the 2013 than at any point in the last five years. Let’s hope this turns out to be correct.
Our upcoming Investment Forum in mid-January will delve into some of these themes in more detail—notably the question of asset-class valuations, China’s growth story and the medium- to long-term inflation outlook. We will bring you more on these themes in the coming weeks.
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