This year will see the continuation of the market’s obsession with the provision of central bank liquidity to capital markets. As expectations of liquidity injections ebbed and flowed throughout 2010, so did allocations to risk assets. In 2011, too, the performance of risk assets will be tied to how the market perceives the behaviour of the Federal Reserve and other central banks.
As we grapple with the dilemma of how to return the global economy to a healthy equilibrium, there are two competing philosophies. The first and most honourable is to increase productivity by education and innovation. The second, which is now looking like the path of least resistance, is to inflate our way out of debt and back to growth by printing money.
History has shown that while this may seem like the least painful option at the time, it can have unintended negative economic and human consequences thereafter.
Europe will also continue to chip away at the market’s confidence. The ambition of its political bureaucracy has overreached the economic fundamentals of the constituent sovereign states. While there is a very strong practical imperative to keep the euro together, this will require extreme changes to the underlying sovereign political structures.
This process will take decades to complete but the next 12 months will play host to some significant developments in this direction, in parallel with the market continuing to challenge the integrity of peripheral Europe.
Having challenged Greece and Ireland, the market will also look for an opportunity to test the solvency of Portugal, Spain and possibly even Italy. Should any of these be found wanting, crisis talks will resume and chatter about the end of the euro will once again dominate financial media.
GDP may be unexpectedly strong in the first half of this year, with recent monetary stimulus and the legacy of recently loose fiscal conditions having a positive effect on growth and equity performance. However, should the Fed decide to turn off the quantitative easing tap in June, equity markets are bound to respond unfavourably, particularly those where speculative money has driven returns, such as emerging markets.
On that basis, we prefer more established markets on a solid footing, such as Japan and the US.
Overall, 2011 will be another year in which central banks and their interventions into capital markets will determine investors’ appetite for risk.
Simon Mungall is head of multi-manager at Ignis Asset Management