Saturday, December 31, 2011

>2012: GLOOM vs. OPTIMISM: WHAT’S IN THE PRICE? - Alexander Treves

2011 has been an intense year for equities globally, with one consistent theme - volatility. Through the tsunami in Japan to unrest in the Middle East, concerns of slowing US and emerging market growth to the survival of the euro region, most equity markets have fallen notably. Would 2012 be any different or does the uncertainty spill over into the next year as well? Alexander Treves, Head of Investments, Fidelity Worldwide Investments, India feels that while the year could be challenging, it also presents an opportunity to build positions in top quality companies that have a long term competitive advantage.

Globally, three key factors that played out this year were the ongoing eurozone sovereign debt crisis, fears of a slowing US economy, and a sharper than expected rise in inflation in emerging markets prompting higher interest rates. Apart from these, we witnessed events such as the surge in commodity prices in the first half of the year due partly to the political stability in Middle East and North Africa, and the Japanese earthquake and tsunami which disrupted the global manufacturing supply chain.

Of these, fears over slowing growth in the US have eased with better than expected performance of the US economy recently. However, refocus on the fiscal / debt position in the US will begin to gain headlines as the presidential elections draw closer through the latter half of the year. Inflation in emerging markets could decline over the coming months and interest rates in many economies are currently on hold. The year could further test the resilience of the emerging market growth story to the economic slowdown in the developed world.

However, it will be the eurozone that is likely to dominate headlines and the situation could worsen further before being contained. Some of the key themes for 2012 could be as below:

2011 has witnessed developments on the economic as well as financial front in the euro region and these have prompted reactive and temporary fixes by eurozone governments. The locus of the crisis has now moved from the periphery to the core economies and even France and Germany have not been spared. Our colleagues in Europe believe we are in the last leg of the sovereign debt crisis, and the closer the crisis moves to the core economies, the faster would be the move towards more decisive action. In that sense, whether the eurozone breaks up or moves towards a credible fiscal union, 2012 is likely to be a challenging year – albeit the challenges will act as catalyst for resolution. Recent political changes in Spain and Italy are significant and new governments are fully focussed on fiscal prudence. Having said that, we may see a general re-pricing of core, AAA rated sovereign debt. We have started to see the beginnings of this process and the markets are ahead of the rating agencies once again. The euro region could enter into recession in view of the constrained bank lending and austerity measures. The length and depth of the recession would be dictated by the policy response from the European Central Bank.

Historically, US stock markets have had a high correlation with those in Europe. The US cannot be immune from its linkages with Europe, be it through exports or financial markets or consumer confidence. The US consumer is still burdened by debt and consumer sentiment is weak, mainly due to high inflation expectations and static growth in real income. Nevertheless, on a positive note, the release of upbeat economic indicators in the recent months, including better than expected growth numbers for the third quarter, have allayed fears of a recession in the US. Our colleagues tracking the US markets believe that corporate profits
in the US are robust.

This has historically been a reliable indicator of job creation, as confirmed by the latest jobs data, and a positive indicator for a rise in capital spending and industrial activity. Nascent signs of stabilisation in house prices, a decline in foreclosures and vacant house units, and a correction in housing inventory point to a
brighter outlook.

Most Emerging Asia economies could not stay immune to the deteriorating situation in the eurozone and sluggish growth in the US, given export linkages to the west. Capital flows to the EM have slowed leading to a further sell-off in the equity markets, tightening of credit conditions, and pressure on some currencies. Some of the countries in the region also face domestic challenges such as a correction in China’s property market, weaker investment sentiment in India, and high household debt weighing on consumption growth in Korea. Recent data releases on the growth front in China and India suggest that economic activity is losing

To read the full report: GLOOM Vs OPTIMISM