Seeking a warmer front in 2012

2011 was an extraordinary year for the financial industry, with many companies and even some countries teetering on the brink of collapse. Can we be more confident as we step in 2012, or will the turbulent conditions continue?
By None

What does the next 12 months hold in store – a warm and inviting climate for exploring new investment opportunities or stormy markets forcing long-only investors to siton the sidelines? 

For now the outlook remains gloomy, with many suggesting that 2011 may have even been the calm before the real storm.

The European turmoil that dashed hopes of a revival last year shows little sign of abating, with the future of many economies still under question and asset classes that were once considered relatively safe – i.e. sovereign bonds – now viewed as highly risky.

The knock-on effect on investment strategies has already been apparent and will continue to pose serious investment decisions for asset managers.

According to data from Strategic Insight, an asset management research and analytics provider owned by Asset International, around US$26.7 billion flowed out of European bond markets in the nine months to the end of Q3 2011, compared to total inflows of US$12.25 billion in 2010 and US$29.06 billion in 2009.

Despite the best efforts of European leaders and financial authorities towards the end of 2011, an end of the region’s woes appear no closer.

 A new European treaty proposed by France and Germany last December designed to shore up the finances of member states and restore market confidence was vetoed by British Prime Minister David Cameron. Further progress on the plan, which is now likely to be transformed into an intergovernmental agreement outside of the existing EU legal framework, is threatened by a number of factors. These include the reluctance of some euro-zone countries to accede to more centralised economic governance despite their relative health compared to others and concerns over the role the European Central Bank would play in supporting financial institutions or sovereigns in times of market stress. There is also debate on the merits of launching a single European bond market, notably in Germany, given the wide and fluctuating differences between the bond yields of individual member states.

With limited light at the end of the tunnel, some financial institutions are reported to have begun preparing for a possible impending break-up of the European Union.

So apparently ‘safe’ fixed income instruments remain on shaky ground. Can equities offer a more positive forecast?

 It is important to note that not all sovereign bonds should be viewed as bad investments. In the US for instance, the benchmark 10-year Treasury bond returned 17% in 2011, its largest gain since 2008.

In any case, it appears equities will not provide the boost investors are looking for, particularly in Europe, where total investment in equities has fallen each year since 2009. Over US$30 billion had exited European equity markets by the end of Q3 2011, compared to an increase of US$11.2 billion in 2010 and US$43.5 billion in 2009, according to the Strategic Insight data.

By comparison, US equity investment ended Q3 2011 having gained US$56 billion, down from US$99.6 billion at the end of 2010. Bloomberg data suggests that investment in US equities was a thankless task last year, with close to zero return on S&P 500 investments, compared to just over 10% in 2010 and over 20% in 2009.

Many market participants have also pointed out that global macroeconomic events have led to high correlations between individual equities, suggesting that stock picking is yielding limited benefits to end-investors.

So where are the bright spots for investors in 2012? 

Emerging markets continue to be a source of relatively high returns but dependence by many of these countries on exports to a faltering Europe could have the knock-on effect of slowing growth.

Nonetheless, Brazil could be a hotspot. Roubini Global Economics is one of several research firms with a positive outlook for Brazil, forecasting that GDP growth rates of 3% in 2011 can be sustained during 2012. Local exchange BM&F Bovespa continues to facilitate international investment large-scale initiatives that include new trading and clearing technology and routing agreements with major US bourses.

The government’s decision in December to remove the IOF tax for equities levied on foreign investment into Brazil could provide yet another incentive to diversify assets.

Talking of BRICs, Russia may also warm the investor’s heart. Russian commodity reserves mean the country is less dependent on Western economies that most others. “Firm oil prices have allowed Russia to insulate itself from the rest of the euro-zone and this should mean good opportunities for equities towards the second quarter, assuming the political situation remains stable,” commented Percival Stanion, head of asset allocation at Baring Asset Management in his 2012 outlook research note. 

Western institutional investors will also be closely watching the completion of the merger between Russian bourses RTS and MICEX as Moscow seeks to attain its goal of becoming a global financial powerhouse.

And even if growth in China does slow to below 8% in Q1 2012, this level is still sufficiently tempting for the market to remain on the radar of many institutions.

Hot tips may be few and far between in 2012, and travel may be the best way to broaden the mind and the bank balance.