Everyone is familiar with the experience: you are on the beach and the sun that was shining so brightly has disappeared behind the clouds. You look up to see how fast the clouds are moving, hoping for a ray of sunshine. That is roughly what we can expect from the stock markets in 2012. The large dark cloud that has been hanging over the market for some time is that of the eurozone crisis. Let’s hope that the (umpteenth) crucial summit of 9 December will provide a bright spell. However, though very welcome, that will still not lead to permanent sunshine. The next cloud is already on its way: the recession in Europe. Looking at the Purchasing Manager Index (PMI), we are already in recession and next year the impact of the public spending cuts will also start to kick in (though we should note, of course, that the decline in confidence indicators like the PMI already partly reflects this development). Another factor to be taken into account is that a satisfactory answer to the eurozone crisis would remove the current reluctance among businesses and households to invest and consume. If growing uncertainty weighs down growth, as the IMF has ‘proven’ with hard figures, then a decrease in uncertainty should provide a positive impulse. Nevertheless, 2012 will be a difficult economic year and investors wonder what to make of the consensus forecast of 9% profit growth and 4% sales growth in Europe, which is above inflation. What’s more, margins are already very high. In the US more than 10% profit growth and 4% sales growth, as well as improving margins, are forecast. So this leaves no room for disappointing macro developments. The picture that emerges is one of jubilation if a solution to the eurozone crisis is found, followed by doubts about future profit growth. Assuming that the US economy manages to move up a gear thanks to Operation Twist or Quantitative Easing 3, a further short-lived bout of euphoria will soon make way for a renewed focus on the political uncertainty: if the Administration and Congress have a different political colour, the chances of getting the US back onto the straight budgetary track look slim. Yet another cloud.
So are there any places where the sunny spells may last a little longer? Certainly. US high-yield bonds are clearly cheap: the market is unduly negative about the economic developments. What’s more, the US will not slip into recession and the base interest rate remains extremely low, which will restrict the number of defaults. In addition, emerging market bonds (and particularly corporate bonds) are attractive, offering clearly higher yields than similar-quality bonds in the West. If you buy these bonds in local currency, you can also benefit from the upward potential of currencies that were recently hard hit by the global increase in risk aversion. Finally, emerging market equities are also an alternative worth considering. Though growth in these economies (e.g. China, India and Brazil) is also slowing down, this creates scope for monetary relaxation. Moreover, growth will remain substantial and the relative price/earnings ratio has decreased further versus western markets (the discount is even larger than normal). When the weather outlook is uncertain, holidaymakers tend to book flights to far-flung sunny destinations. That is certainly worth considering in the investment world.
William De Vijlder
Chief Investment Officer, Strategy & Partners, BNP Paribas Investment Partners
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