Anyone’s guess
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After a torrid and volatile 2011, in which natural disasters, political upheavals and the eurozone crisis have confounded economic predictions, who can say what 2012 will bring? Fund Strategy writers train their binoculars on the year ahead.
Rather than crystal ball forecasting, this first cover story of 2012 is split into three sections. In the first, Adam Lewis looks at which asset classes are likely to do well; in the second, Tomas Hirst considers what will be the big macroeconomic stories; and in the third, Shaun Cumming, writes about what to expect in the funds industry over the next 12 months.
Which asset classes?
Many fund managers are loath to make predictions, given the volatile nature of markets, but some have attempted to do so.
Trevor Greetham, the manager of the £590m Fidelity Multi Asset Strategic fund, says entering 2012 he continues to favour bonds over equities.
“All in all, things look bleak in the near term [for equities], but 2012 has the potential to be a ’V’-shaped year for risk assets if Europe can deal with its political crisis and the US economy responds to stimulus,” he says.
In equities, Greetham favours America because of its relatively defensive attributes and his view that, despite the fiscal deadlock, it remains the most likely country to stimulate its economy to protect growth and jobs.
“Swiss equities are also attractive for their defensive qualities, with the currency hedged,” he adds. “We expect a period of euro and Swiss franc weakness and dollar appreciation.”
Elsewhere, Greetham says his fund remains underweight in commodities, although it is overweight in gold. (Cover story continues below)
While short-term performance of markets is likely to remain volatile, Alec Letchfield, the chief investment officer, wealth, at HSBC Global Asset Management (UK), says his long-term view is that equities will offer the best value in 2012.
”2012 has the potential to be a ’V’-shaped year for risk assets”
“Economic growth is likely to remain under pressure in 2012,” he says. “Although many European companies have robust finances, a lack of confidence has simply deterred them from investing. However, we believe this ignores two key positive factors which point to a brighter long-term future for investors: first, many firms based in the western world are increasingly benefiting from profits in emerging markets, and, second, while the macro outlook for developed markets may continue to be a drag, emerging market equities look set to benefit from a much more supportive economic environment in the region.”
Meanwhile, Letchfield says a combination of inflation and the industrialisation of emerging markets favours physical assets such as property and commodities. He adds that a positive supply-and-demand picture also supports the outlook for commodities.
On emerging markets, Letchfield says HSBC continues to see stronger growth from the region in 2012 compared with developed markets “albeit that the rate of growth may slow somewhat when compared with recent history”. He adds that Latin American equities also look attractively valued, sitting on a price/earnings multiple of about nine times 2012 earnings.
So which fixed-income sectors can be expected to perform most strongly in 2012? John Pattullo, the head of retail fixed income at Henderson, says inflation and interest rates are unlikely to be a major threat, making his key concern the impact of across-the-board deleveraging.
“The disruption in sovereign debt markets means that corporate bond spreads are discounting a lot of bad news,” says Pattullo, who also manages the group’s £1 billion Henderson Strategic Bond fund. “Current yields imply that over a five-year period a cumulative 16% of BBB-rated European corporate bonds will default, which appears excessive when the worst-ever historical figure was 5.8% and the average is 2% (since 1970).
“For the coming year, we favour the lower end of investment grade and the better-rated high-yield bonds. We are wary of AAA-rated investment grade, particularly in the UK, where gilt yields are low as they are being manipulated by the government.”
At the other end of the spectrum, Pattullo is avoiding CCC-rated issuers because he says high debt levels may prove too much of a burden in a low or negative economic growth environment.
Darius McDermott, the managing director of Chelsea Financial Services, says for those investors with the ability to take more risk, “large-cap, dividend-paying companies are where we think the money will be made in 2012”.
“Cash is out,” he says. “With rates below inflation you are losing money as soon as you put it away. Basic-rate taxpayers need accounts paying more than 6% to simply maintain the value of their investment, and higher-rate taxpayers need more than 8%.”
McDermott is also worried about gilts, a strongly performing asset class in 2011. He says: “With record high prices and low yields (some bonds are at 220-years low), the only reason to invest would be as a safe haven. Between corporate bonds and high-yield bonds, I prefer the latter as you are at least being paid for the risk at the moment.”
The macro picture
The big macro stories to watch out for in 2012 will undoubtedly involve a combination of political risk and sovereign debt debates. Whether these end the year in a more stable state than they begin it is likely to dictate how buoyant investors feel in 12 months’ time.
First on the agenda will be looking for signs that European countries are moving from political grandstanding to tangible action in their efforts to resolve the eurozone crisis. Already they have agreed to pass tighter fiscal rules, including a commitment to maximum structural budget deficits of 0.5% of GDP and to increase the firepower of the European Financial Stability Facility (EFSF).
The region, however, remains vulnerable, as is demonstrated by the huge uptake of the European Central Bank’s (ECB) recent loan offers to financial institutions. It allotted a record €489.19 billion (£407.2 billion) in the first of two three-year refinancing operations.
Even with the apparent willingness of the central bank to ease credit conditions, doubts remain over the present plan to save the single currency.
“The plan contains no vision or clarity on the final destination, and provides no bridge to get there,” according to John Greenwood, the chief economist at Invesco Perpetual. “In fact, the tool-kit proposed contains only one tool – more austerity. Proposals to revive growth are notable by their absence.
“Finally, there is no attempt to address the underlying problem of the loss of competitiveness in southern Europe, as reflected in the intraeurozone external payments imbalances – the surpluses in the north and the deficits in the south.”
Market uncertainty could affect bond issues in 2012. With the eurozone as a whole expected to attempt to raise €837 billion in gross debt issuance this year, and Italy alone accounting for €245 billion of it, the impact of higher debt yields could be severe unless they can be brought under control.
Elsewhere, concern will be focused on the world’s largest economy as the run-in to November’s presidential election picks up pace. The failure of the bipartisan “Super Committee” to agree on measures to begin putting America’s public finances on to a stable path has left the country facing the prospect of automatic cuts to healthcare and defence spending.
These cuts would total $1.2-1.5 trillion (£770-960 billion) over the next 10 years, but both Republicans and Democrats are deeply unhappy with the way these would be applied.
Yet the entrenched partisanship that has defined America’s politics since the mid-term elections last year will have to be overcome for any compromise to be reached in deficit reduction. With Republicans looking for a candidate to lead the charge against President Barack Obama in November, the prospects of a softening in rhetoric over the next few months seem slim.
”The disruption in sovereign debt markets means that corporate bond spreads are discounting a lot of bad news”
What this will mean for getting America off the debt debate and on to tackling growth is yet to be seen. The International Monetary Fund’s (IMF) forecast is that America’s economy will grow by only 1.8% in 2012, after 1.5% last year. Though both figures beat the IMF’s anaemic forecast for Britain of 1.1% and 1.6%, neither country has much room to manoeuvre in the event of an external shock.
One risk could come from China. At the end of last year the IMF warned that the Chinese financial system faces “a steady build-up in vulnerabilities” that would necessitate the authorities loosening their grip on the sector.
There has been a notable shift in policy in the country recently, with the People’s Bank of China cutting banks’ reserve requirement ratio by half a percentage point from December 2011. This policy loosening suggests the focus has shifted from cooling inflation to stimulating economic activity and, in particular, easing conditions for the banks.
Some commentators have suggested this is further evidence of a potential hard landing for the country. Nouriel Roubini, an economist nicknamed “Dr Doom” for his prediction of a housing market collapse during the bull market that preceded the financial crisis, has warned that over-investment could be China’s undoing.
In a recent article for the Financial Times Roubini argued that China had “persisted in its weak currency, to support its export and investment-led growth model where savings are too high and consumption too low”. Whether this view ultimately proves correct, the fact that so much of the so-called developed world is relying on external growth to prevent another recession should be a worry in itself.
Outlook for funds on page 2
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