2012: Turbulent year ahead for global stocks
History suggests that stock markets can move sideways for a decade after a big crash. It is reasonable to assume that 2012 will be like 2011, a sideways year with many twists and turns in response to political and economic developments.
The median forecast for US growth for 2012 is 1.8%—low in an absolute sense, but not recessionary. Brazil’s economy has stalled in the third quarter of this year—annualised growth has fallen to 2.1%, coming as it does against the backdrop of a strong 2010, when the economy grew 7.5%. All the three largest emerging economies—China, Brazil and India—are all now slowing, according to their latest GDP figures.
The eurozone crisis is hitting confidence while economic slowdown in Europe and the US is undermining demand both for manufactured goods from emerging markets and for minerals produced by resource-rich countries such as Brazil.
While developed economies have been struggling to generate growth momentum, emerging economies have had the opposite problem. Super-easy monetary and fiscal policy has led to real estate bubbles, capacity constraints and labour shortages.
At first glance, forward price-to-earnings multiples look reasonable, but Shiller PE ratios, which use 10-year averages of earnings, suggest that valuations in the emerging world are still lofty by historical standards.
Prices of petrochemicals are a leading indicator of the global economy—strengthening of crude prices in the second half of 2011 has not translated into higher petrochemicals prices. The price difference between Brent crude and Platts’ composite petrochemicals price index has narrowed to $330 from $580 at the start of 2011.
Across the 423 European corporates rated by S&P, aggregate free cash flow between 2007-2010 rose by 8% to ¤289bn. Cash on the balance sheet is up 33% to ¤637bn. Much of the cash is being held to fund companies’ own inventory during the next downturn.
Judged against the dollar, the euro needs to fall more than 10% just to get back to its low of last summer, even though risks of a disorderly break-up have intensified sharply since then. At $1.29, it is far stronger than its 1999 inception, when the euro’s founders intended it to trade at parity with the dollar. When the euro started, some former currencies were overvalued and others undervalued. Since then, inflation rates have differed. According to IMF, in Luxembourg a euro buys 99 cents’ worth of products, while in Slovenia an exchange rate of $1.53 is needed to maintain parity. Germany’s fair value has steadily risen, to about $1.20 (France is at $1.11).
However, not everything is grim. London Olympics 2012 should boost the UK economy. Almost £6billion of construction contracts have been awarded to British companies and double that amount could emerge from tourism, leisure, hospitality, retail and creative media. Euromonitor International has forecast 29.4 million overseas arrivals to the UK on the back of the Olympics, a 4% rise. US economic measures, such as consumer confidence, home sales and employment, are also pointing to improving fundamentals.
Meanwhile, China has started to ease monetary policy. The last time it did that, China’s excess liquidity fuelled 2009’s global rally in risk assets. In Europe, expectations could scarcely be lower. If the market can convince itself that the euro will survive, asset values could surge.
During the first half of the year, the central banks will try to infuse liquidity and this could cheer global stock markets from time to time. However, this could once again lead to higher commodity prices.
No sooner do central banks try to remove some stimulus towards the middle of 2012, we will see their respective economies decelerate again. This time, along with stock prices, we could see real estate being hit sharply, especially in emerging economies such as China and India, where they have held up reasonably well so far.
US Treasury yields have been in a steadily falling trend for 30 years. Unlike gold, Treasuries are still uncorrelated with commodities and stocks—if more stagnation awaits, US Treasury bonds will mitigate losses on a stock portfolio.
The S&P 500 price-to-earnings multiple, at around 13, might seem low, but not if you factor in weakening corporate profits (based on recent earnings reports).
Yields on deposits and bonds are low and a growing army of baby-boomers-turned-pensioners needs income from somewhere. Companies with high and stable dividends tend to be large and mature, such as US multinational consumer goods companies. Global investors will find it prudent to invest in this space.
Walmart remains persona non grata in the subcontinent, but Ikea, Adidas and Gucci: India welcomes you. These companies should benefit from the opening up of FDI investment in single brand retail in India.
According to Bank for International Settlements (BIS), total claims by European banks on Asia ex-Japan economies stood at $1.4 trillion as of June 2011. Of the total claims from India, 60% or $128.5 billion have a maturity of up to one year. This, together with India’s forex reserves of $311 billion, paints a grim picture for India.
Indian government is scheduled to borrow R1,20,000 crore and R1,50,000 crore through issuance of dated bonds and treasury bills, respectively, in January-March 2012. This heavy supply of bonds will push up bond yields and pull down bond prices, notwithstanding the fact that a CRR cut in the interim by RBI is likely.
Italy needs to refinance a fifth of its sovereign debt next year, with issuance approaching ¤400bn. If 6% and over becomes Italy’s new long-term borrowing cost, it may find itself with the same burden that tipped Ireland and Portugal over the edge. In addition to Italy, Spain’s debt issuance next year could be about ¤150bn. Its 10-year yield, at 5.6%, is also headed higher.
Based on ¤56bn of Italian debt repayment maturities falling due on February 29, 2012, I expect a fall in global stocks in February 2012 on increasing anxieties. I also expect a heavy downturn in global stocks between June-August 2012 and in October 2012. The rest of the year should see reasonable returns for investors.
The author is CEO, Global Money Investor
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