The year 2011 has drawn to a close with most Investors more than happy to consign the year to the history books.
Having started on an optimistic note and having withstood some unexpected blows early in the year from the Japanese earthquake and a spike in oil prices as a result of uncertainties provoked by the Arab Spring, the resurgence of systemic threats emanating from the eurozone have reversed the mood.
Looking into 2012, a positive investment outlook depends upon successfully navigating around some very visible icebergs. Firstly, the eurozone sovereign credit markets must be stabilised. Secondly, the Chinese economic soft landing must not turn into a hard landing. Thirdly, America must avoid stifling a nascent domestic recovery through political intransigence.
The most threatening of the icebergs is clearly the still-unresolved eurozone sovereign debt crisis, which has prompted an accelerated deleveraging of the financial system both within Europe and outside, as the world’s non-European banks and corporations move to insulate themselves from Europe’s problems.
When compounded by fiscal austerity measures that have been deemed to be part of the medicine required to stabilise the situation, the result is that Europe has been almost solely responsible for the undermining of the global growth outlook for 2012.
We believe, however, that substantial progress has recently been made in Europe which holds out the prospect for much reduced stress as the year progresses. Specifically, it now appears that politicians and the European Central Bank are singing from the same hymn sheet with a commonly agreed plan for embedding fiscal discipline in the single currency operating rules whilst the ECB buys the time to implement the plan by providing unlimited support to the banking system – not directly to the sovereign states.
The price of the solution will still be a recession in Europe, but the likelihood of something worse looks to be much reduced.
Moving on to China, the growth miracle built on exports and investment has been compounded over the past couple of years by a rapid expansion of credit, often through new unregulated channels, which has found an outlet in the housing market.
The weakening in demand from developed markets is now being felt and it is feared that as China enters the year of the Dragon, a credit bust similar to America’s could be in the offing. Although this bears watching, we think this will not happen. China will certainly suffer substantial “bad debts” as part of the credit boom, but in a largely state-owned banking system, ultimately lending is state directed and the equity capital can be replenished by over $3 trillion of foreign exchange reserves. In short, China can afford its mistakes and should become a more positive growth force as the year progresses.
America is a different case. The signs are good that after a soft patch a recovery is gaining pace, indeed there is real potential for positive growth surprises if the housing market stabilises in response to record affordability and rapidly deceasing inventory. It is for Congress to avoid snatching defeat from the jaws of victory.
The risks that we have addressed so far leave aside the ever-present fragile geopolitics surrounding Iran and the Middle East which we must hope do not spill over into energy markets at an inconvenient time. So, altogether, it is understandable why stress levels are high.
For a longer term investor however, fear and opportunity are synonymous. With that perspective we continue to hold the view that there is far more to be hopeful about than is commonly believed. In the meantime, supportive monetary policy from all the world’s major central banks, lack of speculative excesses in financial markets and a robustly healthy corporate sector ought to provide a solid buffer against the current chill winds.