Germany and France this week raised the pressure on Greece to a find a solution to its debt crisis amid tense negotiations in the eurozone in what is shaping as a vital preamble to the year ahead.
Fidelity Worldwide Investment commentator, Andrew Webb, says predictions for 2012 are virtually impossible but a meeting of the full EU summit on 30 January may set the tone.
Back in 2008, who would have thought that some Americans’ failure to keep up with their mortgage repayments would claim three European prime ministers and threaten to shatter the continent’s single currency?
And who believed the pessimists that said the financial crisis would take more than a decade to overcome? We resigned ourselves to all these things in 2011 – the year that the true cost of the financial crisis became clear.
It was also the year that popular uprisings across North Africa put fighter jets and frigates in the Mediterranean; Japan suffered a simultaneous earthquake, tsunami and nuclear disaster which knocked huge holes in the global supply chain; and the cast-iron, risk-free investment – US Treasury bonds – became a “risky investment”.
These events led to swings in asset prices and in the 11 months to the end of November, global equities lost 10 per cent. As you might expect, there were large divergences between countries: US equities were flat while the eurozone fell 14 per cent. Greek shares fell 57 per cent, Italy 19 per cent. Australian equities lost almost 6 per cent.
Confidence drained from emerging markets as China stamped on the brakes to slow inflation and weakness in western economies began to bite. In a reflection of the mood, the perceived safe-haven and popular hedge against inflation, gold, rose 23 per cent, while copper, a barometer of growth, fell 19 per cent. Non-euro government bonds performed well, US treasuries overcame their downgrade and gained 9 per cent.
One of the remarkable characteristics of the year has been the tight but volatile ranges in which equities have traded. From January to August, global equities bounced inside a range of around 8 percentage points wide. In August, triggered in part by S&P’s downgrade of the US, a sudden correction took place and since then, shares have remained within a band around 15 per cent lower than the previous level. Rarely has a year seen such a distinct, sideways pattern.
This seems to be a reflection of the uncertainty among investors caused by the tug-of-war between themselves and politicians over the eurozone crisis. European leaders have been slow to get a grip of the crisis and when investors have lost patience with politicians’ progress, they have sent a warning shot through the bond markets. On a purely practical level, politicians need to react to these movements, but don’t like to be seen to be at the mercy of investors.
This struggle inevitably filters into equity markets and the floor in each trading range has been created by prices reaching attractive valuations that are supported by what remain relatively healthy corporate earnings. Each time the bears get hold of the market and drive it lower, bargain hunters who remain faithful to the long-term growth story step in. At the top end of the trading range, momentum grinds to a halt with one of the frequent reminders of the uncertain macro picture: a downgraded growth estimate, or perhaps disappointing economic data.
This risk-on/risk-off pattern will continue into next year unless something happens to break the cycle.
This makes predictions for this year virtually impossible and few people are willing to put their neck on the line to make them.
Risk assets are in suspended animation as investors edge nervously around the problems in the world economy.
More indebted countries are choosing austerity over spending which makes sense if you think of national finances in the same terms as household budgets where spending beyond your means is unsustainable in the long-term. But some argue that national finances more like business finances and that growth is only achievable if investment is made – usually with borrowed money.
But stock markets are not direct proxies for economic growth, they are a reflection of corporate not national earnings. They therefore behave differently to economies. This has been demonstrated at various points in 2011.
Because investors have spent most of last year backing away from risk assets, shares and other assets like them are unloved and therefore many are considered to be relatively good value. If the eurozone crisis comes to a happy conclusion, the risk-on trade will be back in fashion and it could be a good year for investors.
If the eurozone crisis comes to a messy conclusion, it could be terrible. That is why, despite the criticism, Europe’s leaders are working seven days a week to solve the crisis.
Andrew Webb is an investment commentator for Fidelity Worldwide Investment.
