Every EU summit seems to bring us gradually closer to some sort of medium-term fix on the European debt issues but we expect political and social tensions to continue globally for a variety of reasons.
We are likely to see significant volatility, with strong market moves in both directions but with levels quite possibly ending up close to where they began.
Global growth should be positive, led by emerging markets and Asia, with potential further support from the US. Given the political back-drop of perpetual tensions in Europe and stalemate in the US, combined with presidential elections in the US, France and Russia and the transition to the new leadership in China, politicians, and the impact of their action (or inaction) will continue to affect sentiment at times. This will be a critical year for the eurozone and future integration of the 17 member states, with significant downside potential if this is handled poorly.
What is positive is that the central banks are clearly aware of the systemic risks and are willing and able to expand their balance sheets further to maintain the stability of the system, giving banks the breathing space required to reduce leverage and repair their own balance sheets. Companies remain in very good health, with strong balance sheets and significant amounts of cash. Earnings are likely to adjust to the slower pace of economic activity but will still make positive progress and this again may be a reason for the quality companies to be re-rated as the market begins to favour companies with the most attractive fundamentals.
Equity markets are likely to continue to trade within broad ranges until there is more visibility on sovereign debt and economic growth. As was shown at times in 2011, equity markets can bounce and recover lost ground very quickly as investor sentiment moved out of the doldrums from time to time. We believe equities are attractively priced and provide better compensation for investors than bonds or cash.
We should remember that stockmarkets are a discounting mechanism and equities tend to bottom before the bad news has peaked. It is hard to say if we have yet passed this point but it does feel that investor sentiment remains deeply negative, providing opportunity if pessimism subsides. It is worth noting that company directors’ share buying has rebounded and when the people closest to the businesses are buying this is also usually a positive signal.
In a scenario where we have more clarity on Europe and the health of economies, we would hope to see fundamentals reassert themselves and the market rewarding the strongest companies. The end of the risk-on, risk-off market with asset classes highly correlated should be welcomed by investors.
Nevertheless, there are many hurdles to clear first. One thing we can be sure of is that this will not be a calm year but there is a fair chance it will be better than 2011.
Gary Potter is co-head of Thames River Multi-Capital