As a rule, investment banks tend to be optimistic about the future, certainly the major US houses. Not so for 2012! The recent outlook statements have been unusually cautious. This may not be a bad thing, as low expectations are more easily beaten than high ones. Of course, the investment environment will be challenging, given the eurocrisis and the likely decline in corporate earnings. But with earnings currently at record highs and corporate balance sheets in excellent shape, equities still offer opportunities.
One of the outstanding features of 2011 is the fact that financial markets increasingly tend to enforce policy decisions, rather than just react to them. In all likelihood, they will also enforce a more durable solution tot the eurocrisis, speeding up policymaking which would otherwise have spanned many years. A disintegration of the eurozone (which would be disastrous) remains a tail risk which investors should neither ignore nor embrace. It is just another reason for broad diversification, which is always a prudent thing to do.
The high dividends of (European) telecoms and utilities should be viewed with some caution, since their sustainability is an issue.
Ad van Tiggelen
In order to see what might work for investors in 2012, it is important to understand the lessons of 2011:
Financial markets continue to be growth addicts, not unlike US consumers.
In order to sustain growth, markets are willing to accept amazing levels of debt financing, as long as they perceive a country or company as being competitive, flexible and having sufficient access to liquidity.
As for this liquidity, central banks increasingly have to be seen as a credible lender of last resort. Without that perception, credit markets dry up, creating a downward spiral which eventually also threatens solvency.
Of these issues, liquidity is the most important one in the short term. The reason that the level of UK long bond yields is now similar to that in Germany, despite the evident superiority of German fundamentals, is due to liquidity. The Bank of England is seen as a credible lender of last resort, the ECB not (yet). Liquidity buys time! And Southern Europe needs time to address its lack of competitiveness and flexibility, closely monitored by regulators and financial markets.
It is likely that solutions will be found to get liquidity in the eurozone going again. Depending on the success of this, the eurozone will face a severe recession or just a mild one. At the same time, markets have implicitly given a “licence” to the US policymakers to keep stimulating the economy, also in 2012. This may help the US to prevent a recession, even if growth will remain very modest. Emerging markets still appear to be in decent shape, with slower growth possibly being compensated by declines in interest rates.
Ad van Tiggelen
The scenario painted above, which will lead to modest earnings declines in most developed markets and some earnings growth in emerging markets, is largely discounted in current equity valuations. Given low expectations, surprises could just as easily be on the upside as on the downside. In this scenario, we see equity prices as having limited up- or downside, making dividends a very important driver of overall returns.
So what do we like? We prefer investments in large, international companies with good access to capital markets, some growth en decent dividend yields. This means that we like energy stocks (esp. oil majors) and big pharma and food companies for their dividends and leading technology companies for their growth. The high dividends of (European) telecoms and utilities should be viewed with some caution, since their sustainability is an issue. Financials and cyclicals would benefit most from a decisive solution tot the eurocrisis, but we see a gradual progression with ups and downs as more likely.
