Many of the themes and issues that determined financial market returns in 2012 may well return for an encore in the New Year. With 2012 is already behind, businesses across the world already are looking ahead to the New Year, with all of its risks and opportunities. Historians argue that to understand where we may be going next, it helps to know where we have been. Given that many pundits believe that many of this year’s trends – the cycling between “risk on” and “risk off” moods in the financial markets, the involvement of central banks in shaping returns, the various fiscal crises in Europe and the United States – will return for a repeat performance in 2013, these series of Data stream charts, developed by Alpha Now, provide a look back at the events of 2012 that will be of help to plan for the new year.
Asset Performance in 2012
In spite of all the sometimes dramatic gyrations between “risk on” and “risk off” investing in most global markets throughout 2012, virtually all major asset classes – if not all markets – were on target to finish the year in the black. The increasingly intense quest for yield is reflected in the strong gains recorded by both emerging market debt and corporate high-yield debt, while worries about financial assets and the prospect of a fresh global recession sent many investors in quest of safe havens in the form of precious metals or sovereign debt issued by developed nations, relinquishing the promise of yield today for some sense of safety as 2013 seems likely to dawn amidst plenty more uncertainty. The only bear markets were confined to pockets of the commodities arena, notably crude oil, coffee and other ‘soft’ commodities.
2012: The Tug of War Between Fear and Greed
Throughout the year, the pendulum swung back and forth between fear and greed, depending on the news flow and the mood of the moment. Those gyrations can be seen in this chart, which reflects a technical analysis of the movements in technology and consumer discretionary stocks (as represented by two exchange-traded funds) against those of two more defensive sectors, healthcare and consumer stages. Most investors expect that pattern to remain intact at least in the early months of 2013, as macro considerations – the eurozone crisis,U.S.debt negotiations and Chinese growth – war with company fundamentals for dominance in the market.
Central bank rates and assets
One important hallmark of 2012 – as with so many of the years that preceded it and that followed the financial crisis of 2008 – was the willingness of central banks to inflate their balance sheets by serving as a buyer for all kinds of debt market assets, from Treasury securities to mortgages. The Fed embarked on “Operation Twist” and a third round of quantitative easing in autumn, while the European Central Bank along with the central banks inJapanandChinawere active participants in the open market. The result is that central bank assets surged to fresh records – while interest rates stayed at rock-bottom levels. These unprecedented actions kept interest rates at rock bottom levels and sparked speculation of a bond bubble, as corporations rushed to issue new debt. So low had rates fallen by year end that traders in the junk bond market, which historically has preferred to be known as the “high yield” market, quipped that they would have to go in quest of a new moniker, given the rates at which companies with a below investment-grade rating could raise new capital.
China‘s Growth Year to Date
It was in 2012 that the folly of relying solely on China to become the sole engine for global economic became apparent. The country’s economic growth rate slipped significantly, although analysts and pundits struggled for much of the year to gauge just how much China was flagging. In the final weeks of the year, there were some grounds for cautious optimism in the shape of a modest improvement in a manufacturing report and gains in corporate earnings. But the year as a whole reminded investors that as long as the health of China’s economy relies on its exports to other markets – including the slow-growth United States and the troubled eurozone – it will be hard for the country to sustain its own growth rates, far less help spark growth elsewhere. Not surprisingly, Chinese stocks lagged the MSCI World Index dramatically, as investors fled when it became clear it would be difficult for Chinese companies to deliver on the high expectations that had been priced into their stock valuations.
PIGS: Debt & bond Yields
Much of the uncertainty that affected global markets throughout 2012 can be traced back to the eurozone’s ongoing fiscal and banking crisis. While 2012 did witness some signs of progress – the agreement to provide funds directly to struggling banks rather than simply make more loans to already burdened national governments; European Central Bank President Mario Draghi’s pledge to do “whatever it takes” to save the common currency, the election of a Greek government (on the second attempt) willing to accept some degree of austerity – it also made it clear that finding a solution to the crisis will be a long, drawn-out process. And in most of the ‘PIGS’ nations – those countries on the eurozone’s periphery that are facing the biggest fiscal and banking system crises – bond yields remained high or continued to climb, along with unemployment rates and other hallmarks of distress.
Stock Prices Advance Despite The Earnings Trough
En the United States, earning growth rates slowed dramatically over the course of 2012, while corporate revenues for S&P 500 companies faltered even more, turning negative in many instances and requiring companies to squeeze out what meager growth in profits they could still manage by cutting costs. Even so, by mid-December, just after the third-quarter earnings season wrapped up with what many analysts hoped would mark the trough in this profits cycle, the S&P 500 was still ahead some 15pc for the year. Similar patterns were seen worldwide, with most of those sectors that did post stock price gains for 2012 doing so in spite of seeing their earnings actually contract over the year.
The Core’s Exposure to the Periphery’s Woes
Early in the year, uncertainty surrounded the prospect of what became referred to as a “Grexit” – a Greek departure from the Eurozone. But by late in 2012, it was the members of the core – such asGermany, theNetherlands, and theUnited Kingdom- that were displaying their unhappiness with the state of affairs in the European Union. WhileGermanyhas displayed this by demanding austerity budgets in exchange for bailout help, in theUKpolitical rhetoric has reached the point where an exit referendum is being discussed as a possibility. Meanwhile, Britain put its foot down when it came to passing the EU’s next budget, pushing for what Prime Minister David Cameron called real cuts, in light of the fact that member states are in austerity mode.
Looming Ahead: The Dreaded U.S. Fiscal Cliff
As the months passed, anxiety about the phenomenon referred to as the ‘fiscal cliff’ began to mount in the United States, and among the country’s trading partners. If the sharply divided U.S. Congress and the Obama administration can’t reach agreement on a way to resolve the country’s growing fiscal imbalances and curb the growth in both the deficit and debt [which they did early last week], then a draconian package of across-the board spending cuts will kick in, effective January 1, 2013, along with the end to an array of tax cuts put in place about a decade ago. Many economists agree that the outcome would be not only a further loss in global confidence in the ability of the United States government to govern its own finances, but an economic setback that could even tip the country back into recession.
Wheat Prices and Weather
The summer months of 2012 witnessed an appalling drought in the U.S. Midwest that helped send the prices of key agricultural prices soaring and raised fears about the impact of high corn prices on food prices more broadly. But the U.S.drought was not the first or last shock to global commodity prices of late. As far back as the summer of 2010, a drought that devastated Russian harvests drove global wheat prices north of six dollars per bushel, a price level that traders now view as a floor rather than a ceiling. And even as the summer approached an end came word that both Russia and the UK were reporting their own crop failures. Trends like this are likely to keep commodities markets interesting for investors to watch in the new year, along with the fact that Middle Eastern tensions remain high (affecting the energy market) and investors have acquired a taste for precious metals as safe haven holdings.
Facebook Does a Faceplant
Although some 140 companies have gone public in 2012, as of this writing, the IPO that dominated the headlines from January right through to December was the initial offering of stock in Facebook (FB.O) – and the cluster of other newly-public social media companies. The behemoth transaction raised questions and eyebrows even before it was priced, given what many saw as aggressive pricing and valuation on the part of Facebook’s underwriters. Then, the first day of trading proved to be a debacle, as Facebook’s share price briefly jumped only to plunge amidst market-wide system failures that made it impossible for anyone who wished to sell the shares they had bought – or even to keep them informed of what they had bought and at what price. Even at the time of Facebook’s debut in midyear, only Linkedin was trading above the issue price, and by year-end, the same was true. Social networking may be a popular application for its users, but public companies of this ilk have yet to demonstrate that they will generate gains for investors.
The Market takes a Bite out of Apple
The Great Apple Conundrum was another hallmark of 2012. On one hand, Apple (AAPL.O) continued to roll out new products, a new iPad, a new iPhone and finally its brand new iPad mini, all of which found favor with consumers and that found eager buyers forced to wait to get their hands on the premium-priced new devices. The company even began returning some of its mountain of cash to investors midway through the year. Earlier in 2012, analysts had begun forming a “700 Club” of sorts, comprised of those who expected the company’s share price to soar above 700 dollars a share. Instead, by the final months of the year, investors were dumping Apple on the slightest excuse, ranging from modest earnings disappointments to anxiety about the impact of possible tax hikes on dividend income on dividend-paying companies like Apple. One of the more logical theories is that in spite of the fact that Applie triumphed in a patent lawsuit over rival Samsung, Android-based devices ranging from rival smartphones to the Amazon (AMZN.O) Kindle might continue to nibble away at Apple’s market dominance and erode its profit margins.
Welcome to the Venezuelan Twilight Zone
If China,Brazil and some of the other outsized emerging markets disappointed in 2012, their smaller peers more than made up for it. But while countries like Pakistan,Turkey and South Africa posted healthy double digit returns, the crown belongs toVenezuela, which saw stock market valuations soar by an astonishing 200pc or more. (Some of those gains came amid reports of President Hugo Chavez’s health woes; some were attributed to the fact that Chavez spent massively to boost the country’s economy ahead of a 2012 election.) The problem? Well, not only does GDP growth not always translate into growth in corporate profits, but, in the words of one Fidelity portfolio manager, to many investors Venezuelan markets appear “uninvestable” because of the degree of political interference and the lack of corporate governance. Some investors have pointed out that the country’s bonds offer an alternative. Overall, the list of top performing emerging markets this year is a sharp reminder that with rare exceptions, there is a clear link between above-average returns and higher risk levels. After all,Pakistan, while offering healthy gains to investors, appears to be engaged in the midst of a kind of civil war.
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