So what does 2012 hold in store?  

The focus for the year ahead is still very much on the news out of Europe.

In a recent publication to advisors, Matt Sherwood, Perpetual’s Head of Investment Market Research said that ‘markets are extremely volatile and as this is a confidence game more than anything else. Until a solution is found (in Europe) cheap sharemarket valuations will not trigger a recover.y’

2012 has some similarities to 2011

With the European situation likely to be present well into the New Year, investors might think that there are now four certainties in life; death, taxes, Black Caviar winning and that 2012 will be a repeat of 2011.

There is little doubt that this year’s outcomes are likely to be influenced by Europe and questions about the speed and sustainability of the global recovery. As such, some investors might conclude that market risk premiums will be elevated and price indices will remain range-bound with above-average volatility.

However, it is important to recognise that some key features of 2012 will be different to 2011.

 1.    Share valuations are low. UK and US sharemarket valuations are currently well below their respective long term average.

 2.    Valuations in other markets have risen. US 10-year bond prices are near an all-time high. Meanwhile, UK 10-year bonds are at an all-time high.  Meanwhile, gold has risen near-20% in 2011 to a new year-end high (in both nominal and real terms). These record valuations suggest that the successful strategy of 2011 may be less compelling in 2012 and are no longer attractive alternatives.

 3.    Earnings growth is set to moderate. While profit margins have most likely peaked and analysts are likely to revise their 2012 growth rates, earnings growth should continue as long as global growth remains positive. If growth is sustained, then earnings growth will mostly be driven by cost-side management and the majority of costs are labour costs, which in a world of sluggish growth and high unemployment should remain subdued. The combination of reasonable profits and cheap valuations are likely to provide some support to both global share markets and global corporate bond markets.

 4.    Emerging economies’ inflation has peaked and authorities can provide support. While advanced economy interest rates being at historic lows has not engineered a strong recovery, balance sheets in the emerging economies are in good shape and as such policy easing is likely to be successful in boosting spending. The key for market trends is whether renewed Asian strength is capable of outweighing any downturn from Europe.

Implications for asset allocation and investors

There is little doubt that until the issues in Europe are resolved, risks remain elevated in all markets, volatility will be high and asset markets will be unusually correlated. In this market, a much larger part of investors’ total return is likely to come from income, whether it is dividend income or coupon payments from corporate bonds. It may be the case that 2011’s winning investment strategies such as government bonds and precious metals may have lower returns, given their high starting valuations. In this environment, investing in ‘low risk’ ‘quality’ assets (irrespective of which asset class you are in) and regular portfolio re-balancing (when securities have been oversold or overbought) will help mitigate risk. The overall key here is for seeking exposure to quality income producing assets in both the equities and the debt markets and hoping that the European debt crisis is resolved by the politicians. One can’t help but think that history is being written as we speak.
Robson Partners are encouraging all investors to review their asset allocation position to ensure it is best suited for the future (and this may not be what was best last year). Should you like us to review your portfolio, please contact us to book a complimentary appointment.