Market outlook

Overall we think that 2012 will be a positive year for global equity markets. Valuations in many markets are very low following the strong growth in earnings over the last few years. And we believe equities are close to their cheapest ever relative to US government bonds, while the same picture is true if you compare US equities to cash.

Whilst global growth expectations are at their lowest since 2008 and corporate profit growth is set to slow next year, we still expect companies will be able to increase profits. We also expect confidence to improve increasing the demand for risk assets such as equities.

Government bond yields in the core markets of the US, UK, Germany and Japan are close to the lowest yields of all time. Whilst we are not expecting any rate increases by any of the core central banks until at least 2013, we think that bond yields will rise as the global economy recovers in the second half of the year. Spanish, Italian and other peripheral government bond yields should fall.

We also think that emerging market equities will outperform developed market equities. The trigger for this outperformance is likely to be falling inflation which should lead to lower interest rates in most emerging economies. Lower debts and deficits and stronger growth than in the developed world should also support emerging market equities relative to developed market equities. In China, we expect inflation to fall sharply to 3% or lower next year allowing the PBOC to cut reserve requirements and interest rates.

We think that investment grade, high yield and emerging market debt will outperform government bonds in 2012. Following recent falls, valuations are favourable with spreads on high yield and investment grade pricing in a much higher risk of default than we think likely.

Summary

In summary we think that 2012 will be a year of healing for the global economy, which should lead to stronger equity and non-government bond markets. We think the crisis in the eurozone will be contained, although deficit reduction is likely to remain a theme in almost all developed economies for the next few years. However, with the risk of a catastrophic meltdown greatly reduced we think that equities will climb a ‘wall
of worry’ in the first half of the year while a recovery in the global economy should help risk markets in the second half. Fig 1 summarises
our views for 2012.

• Global economy to be very weak in H1 2012, but H2 2012 and 2013 better.
• Inflation to fall worldwide, leading to monetary easing in most countries.
• Eurozone to stay in a recession until at least mid-2012 – peripheral economies to underperform.
• After much disagreement the European debt crisis will be ‘resolved’, in that its performance doesn’t impact significantly on other economies.
• China will achieve a soft landing and then pick up in H2 2012.
• Equities will potentially be held back at the start of 2012 until an agreement in the Eurozone is reached, leading to much higher equities thereafter.
• Chinese equities in particular and emerging markets in general to outperform developed markets as growth stabilises, while inflation and interest rates fall.
• Non-government bond spreads to narrow as corporates remain in good shape.