January 18, 2012
Our 2012 outlook calls for a "tug of war" between the prospects for improving growth from the G-2 (United States and China) and the European sovereign debt crisis. Economic growth continues to be stunted by the depressive effects of deleveraging across the developed markets. Inflationary trends have begun to recede in emerging markets, which we believe sets the stage for a sustained period of easier monetary policy. Investor risk appetites remain low, as high volatility and headline risk from Europe offset an attractive valuation picture for equities. A positive surprise in European fiscal policy, in an environment of stable global growth, is a potential upside risk for global stock markets.
Monetary policy in Europe has become significantly more accommodative under new European Central Bank (ECB) head Mario Draghi. While European politicians continue to fumble an aggressive policy response, the ECB recently introduced an unlimited three-year liquidity facility for European financial institutions. This has led to a significant improvement in yields on shorter-term bonds from Spain and Italy, while progress on longer-term bonds has been slower. The ECB's action has bought some time for politicians to advance their policy plans, while also measurably reducing the odds of a financial accident. The overall magnitude of the debt burden hasn't been reduced, however, and it will take improved growth and spending plans to entice private investors back in force.
U.S. growth has been surprising to the upside, as we anticipated. We expect Europe, however, to undershoot the relatively benign consensus growth forecasts for 2012. Markets don't stand still, however, and the euro's 14% decline over the eight months improves the outlook for Europe's exporters. While near-term trends still show deceleration in emerging market economies, we expect this to stabilize and then reaccelerate as the year progresses with continued easing of monetary conditions. The prospects of stronger G-2 economic growth would help Europe buy time for further progress in developing its "fiscal compact" and calming the bond markets.
- Flat S&P 500 performance in 2011 masked considerable volatility
- We have established our 2012 S&P 500 earnings per share (EPS) estimate at $102
- Emerging market equities relative performance lagged heavily in late 2011
- Evidence of China's economic rebound, and overall investor risk appetite, will drive 2012 performance
Europe & Asia Pacific Equity
- Political factors pushed 2011 European Union (EU) market volatility to recent highs
- Economic stability going forward will depend on development of clear EU roadmap
U.S. Fixed Income
- Declining interest rates and improving fundamentals drove strong municipal bond returns in 2011
- Our steady interest-rate outlook should support continued solid returns in 2012
U.S. High Yield
- High yield fund flows have become increasingly volatile during the past four years
- Investment strategies based on fund flow volatility can result in investment opportunities
Global Real Estate
- 2011 marked a poor year for global real estate investment trusts (REITs), which fell 8%
- Vacancy rates tell a mixed story for 2012
- Commodity-intensive, fixed-asset investment has been a key growth driver in China
- We see technically complex, softer, industries as the next growth driver
We entered 2012 with a neutral stance, as we see continued deleveraging capping upside potential, while easy monetary policy and attractive equity valuations help cushion the downside risk. Growth in the United States and emerging markets should modestly beat expectations, offsetting a likely disappointing result from the eurozone. With the most recent Federal Reserve statement to keep short-term interest rates near zero through late 2014, we see a steady interest-rate picture in 2012. Along with strong corporate fundamentals, we think this makes U.S. high yield bonds particularly attractive. We still favor U.S. equities over their developed-market counterparts, because of less systemic risk. Disappointing G-2 growth in 2012 is our biggest potential concern, as steady growth in the United States and emerging markets helps buy European policy makers more time to get their fiscal house in order. We also think that evidence of a reacceleration of emerging market growth could be a key driver of an eventual increase in investor risk appetite.