2012’s off to a pretty good start as investors and traders look to the bright side after a volatile 2011.
Last year, the vast majority of world markets closed in the red, some deeply so. One exception: the US, which broke even or gained slightly, depending on whether you owned stocks that paid dividends.
And it’s not hard to see why. The effects of the worst financial crisis since the Great Depression linger. The debt bomb that first exploded in the US had knock-on effects around the world, as governments took on liabilities originally assumed by households and banks. And now governments must clean up the mess.
That very involvement by politicians whose incentives are often antithetical to those of investors makes it particularly difficult to make predictions about markets this year, when US elections bring everything to a halt.
Then there are “black swan” events, like last year’s Japanese earthquake, tsunami, and nuclear meltdown, which nobody can predict but can affect our portfolios profoundly.
OK, enough excuses. Making predictions is part of my job—and honestly it’s a lot of fun—so here are the trends I think will drive markets most in 2012.
1. The European debt crisis will drag on, but there may be some progress.
Greece is pretty hopeless, and there are fresh rumors that it will leave the Eurozone. And the Spanish government just said that its deficit as a percentage of GDP will exceed its targets. Oops.
Meanwhile, Eurozone nations must issue nearly €800 billion in debt this year, €300 billion from Italy and Spain alone. A lot of that will come early on, so we could have some bumpy days ahead.
But yields have come down as a new government in Italy tries to push through reforms. And don’t underestimate the willingness of the European Central Bank under Mario Draghi to take a page from Ben Bernanke’s playbook and flood the zone with cash if things get rough.
Also, though the naysayers may disagree, I think European governments are making slow, painful progress towards a solution—namely, more fiscal integration. I expect that to continue this year, too.
2. Still, several European countries will go into recession, and some could lose their AAA rating this year.
Hey, no one said it was going to be easy! Recession may already have started in Italy, and who cares what you call it in Spain, where unemployment approaches 23%. But austerity programs also could push countries like France and Belgium, but probably not Germany, into a mild recession.
Unfortunately, the lower tax revenues that come with recessions cause deficits to grow, which makes ratings downgrades likely. France’s AAA is a goner, but probably after the April presidential election. (Who wants to face the wrath of Sarkozy?) Even Germany and the Netherlands could be downgraded if they take on more of the debt of their southern cousins.
So, before the year is out, the AA+ club (which includes the US) may be very crowded.
Was it Groucho Marx or Woody Allen who said they didn’t want to be a member of any club that would accept them? Now we know what they meant!
3. The US will avoid recession for much of the year, and growth will be decent.
This may be a bitter pill for many of you to swallow, but the US economy has been remarkably resilient over the last year or so. I know, I know, the housing market is still comatose, and real unemployment is much higher than the statistics tell us, so there’s plenty of misery out there.
But let’s give capitalism some credit: US businesspeople have proven adept at competing in the “new normal.” Recent manufacturing and consumer spending data have been strong. US exporters have done well in emerging markets, and US banks took advantage of free money in 2009 and 2010 to raise tons of capital, unlike their European counterparts.
So, I’m looking for decent growth in 2012—no great shakes, maybe 2% or so—and continued slow improvement in private-sector employment throughout the year. Depending on the outcome of the election, the last couple of months may be rocky, however.
4. US stocks should have a decent year, too, though the cyclical bull market is near its end.
By some measures, valuations are pretty good—about 13 times projected earnings for the S&P 500 index. But earnings growth should taper off to mid-single-digit percentage increases.
2012 is an election year, historically the second best of the four-year presidential election cycle. This time may be different for all kinds of reasons, but since October 3, when the S&P closed at 1,099.23, stocks have gained 16%. We have only another 7% or so to get back to the post-crash high of 1,370. So, it’s not as outlandish as it may sound.
But defensive sectors set the pace last year, and that should continue as growth slows. Unfortunately, that’s typically a sign of a bull that’s long in the tooth.
And the first year of a president’s term is usually the worst for stocks. It may be even more so in 2013, when spending cuts and tax increases could hit all at once, but that’s for next year’s column.
5. Emerging markets continue to lose their luster.
In case you haven’t noticed, many emerging markets are deep in bearish territory. The BRICs have been a disaster—China, Russia, and Brazil all fell more than 20% in dollar terms in 2011, and India plunged 37.8%, according to MSCI.
The trouble is, a slowing world economy is catching up with the former high flyers, most of which are still export-oriented. Also, unlike the US and Europe, emerging economies have faced strong inflationary headwinds, and their central banks have struggled to balance growth and price stability.
6. Black swans are lurking.
Almost by definition, you can’t predict which black swan will appear and when. A market event like May 2010’s flash crash is bound to happen again, maybe this year, maybe next. And of course, natural disasters are always with us, most of them unexpected, too.
But I think a whopper of a geopolitical crisis may be the most likely black swan event. One of the most vulnerable areas is the Korean peninsula, where the death of Kim Jong Il and the elevation of his callow son, Kim Jong Un, have caused jitters.
The other, of course, is Iran, which just warned the US not to send an aircraft carrier back into the Strait of Hormuz, through which 20% of the world’s oil supply flows.
And then there’s Russia. Will former President Vladimir Putin just stand by as demonstrators tell him not to run for yet another term? Or will he use force to suppress them and re-assume power? What would happen then?
That’s the thing about the future—there are usually more questions than answers, even as gurus and pundits pretend there aren’t. And politics and markets are more intertwined than ever, which should make 2012 even more unpredictable—and interesting.