Outlook 2012
This year’s global question is whether the world can keep growing while Europe ails. It probably can, but uneasily.
United Kingdom
The UK remains in a position of relative strength compared to its European neighbours and has retained its AAA credit rating. Interest rates are expected to stay at the historic low of 0.5% throughout 2012. Although the most recent data indicates that inflation rates are falling, the fuel duty rise in August 2012 could cause an increase in inflationary pressure later in the year. Additionally, if economic indicators continue to deteriorate, further quantitative easing could be undertaken, which would eventually feed in to the rate of inflation. The ability of the coalition government to push through spending cuts in order to eliminate the structural deficit is likely to be severely tested in the coming months. On the positive side; the retail, travel and leisure sectors are all expected to be buoyed by the Olympic Games. On the stock market, larger UK companies that derive a substantial proportion of their income from emerging markets are likely to be the top performers.
United States
Outside of Europe, the world looks somewhat better. The US stock market was one of the few major equity markets to deliver a positive return in 2011. Historically, market sentiment has been boosted in the year of a presidential election, and early indications are that this will, once again, be the case in 2012. US employment figures are improving and the housing market shows nascent improvement. However, the fiscal deficit remains enormous and must be reduced. It is unclear whether the Fed will embark on a third round of quantitative easing, but if the US economy seems to be running out of steam the Fed is likely to take this route, which could ultimately backfire by raising commodity prices, especially the oil price, creating a headwind for economic growth and inflationary pressures.
Emerging Markets
The biggest challenge for emerging markets is to shift away from inflation and yet sustain growth in an environment where developed markets are importing less and risk-averse investors are less willing to commit capital. The world needs an increase in consumption within emerging markets. This would allow China and other countries running big trade surpluses to rebalance and would provide the developed markets with more open export markets, especially for luxury goods.
China’s chances of a “soft landing” have been enhanced by the most recent GDP figures, indicating 8.9% growth in the fourth quarter of 2011. However, growth could be below 9% in 2012 because of falling house prices, a slump in property investment and slowing exports. China’s growth-obsessed leadership may well act to stimulate the economy. Indeed, China’s leadership change in late 2012 represents a political risk which is likely to give even more prominence to domestic considerations of keeping a lid on social unrest and furthering employment.
In India, policymakers are facing a tightrope walk to maintain growth whilst dampening inflation. For investors to regain confidence in this market it is imperative that strides are made in combating corruption and that reforms to permit foreign competition in retail markets are passed. Elections are scheduled for seven legislative assemblies in 2012. Uttar Pradesh goes to the poll in February, followed by Gujarat in April. Markets could rebound if the results of these polls are viewed favourably.
Brazil could be impacted by the global slowdown, in the form of reduced demand for its commodity exports. However, the government has displayed a proactive and flexible policy stance. Growth is expected to get a boost from further interest rate cuts and the government has also unveiled a series of tax cuts and credit measures aimed at strengthening local demand. In the long run this resource-rich democracy ought to outperform.
Gold
The gold spot price has been rising for over a decade and supportive factors persist to extend the rally into 2012. The price is likely to gain support from the Eurozone debt crisis, loose monetary policy in advanced economies and increasing intervention by central banks in currency markets. Generally robust physical demand from India and, increasingly, China will also help to keep the price high.
A substantial disconnect has developed between the price of gold and the price of mining companies. In the last 3 years, whilst gold prices have risen and stayed high, the price/earnings ratios of gold miners have decreased. That means the mining sector is currently undervalued. With the price of gold set to remain high, these companies are only going to get more profitable and many have begun to pay attractive dividends. In the long-run, when the price reconnects, investment in these companies should pay off.
Energy
The crude oil price is facing both supporting and negating factors. Eurozone debt problems, sluggish economic growth in developed economies and a slowdown in emerging markets ought to bring the price down. However, tensions in the Middle East and a tight global demand-supply balance are currently supporting prices. This is not good news, because high oil prices are a headwind to global recovery.
The natural gas market is oversupplied and prices have collapsed. Prices are likely to remain low in at least the first half of 2012 due to the shale-driven glut of natural gas on the US market and an extremely mild winter in both the US and Europe.
Conclusion
The outlook for 2012 is neither promising, nor hopeless. The world economy has faced real threats since 2008 and has so far averted a full-scale meltdown. Policymakers will have to be resourceful to resolve the Eurozone crisis, but the fact that the US is showing tentative signs of recovery gives cause for hope. The divergence in growth rates between developed and emerging economies will, once again, be in clear focus this year, but whether this will be reflected in asset pricing will depend upon investor’s appetite for perceived risks.
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