2011 has been more about preserving capital, rather than a return on investment. We reflect on year that was, plus look to the horizon of 2012 and beyond.
2011 – the year that was
It could be defined as the year of 'headline risk', where fundamentals have meant little and traders, or increasingly programme trades, have reacted to comments from finance officials, and headline news.
Investors have had to revise their strategies, with the traditional 'buy and hold' model being replaced by a more active approach.
Trading around major global events
Traders have had to handle major events such as the Japanese earthquake and nuclear meltdown, democracy in the Middle East, the US debt ceiling debacle and credit rating downgrade, a potential (though unlikely, in our opinion) hard landing in China, and the European debt crisis.
The 'risk on, risk off' trade has been in full force throughout 2011, which lead to heightened interconnectivity between asset classes. Positive sentiment from either good economic data or government officials' comments saw traders go long risk forex (EUR, AUD, NZD, and GBP), commodities and/or equities, while selling out of bonds and the USD. However, any negative headline had traders fleeing to the perceived safety of the greenback, JPY and until recently, CHF. This will no doubt continue well into 2012, and perhaps 2013.
The markets' performance
Asset class performance has shown that it has been more profitable for the bears. Global equities have seen double-digit declines, although the US has held up well. In forex markets, the yen is the best performer relative to the greenback (up 5.5%), with the NZD falling 3.3% to be the worst in the G10 complex. Gold is up 20%, respecting its multi-year uptrend. The Australian ten-year bond has dropped 152 basis points (-27%), outperformed however by US ten-year treasuries, which despite the improvement in data in Q3 are still down 39%, or 131 basis points. Fixed income has been the place to be, despite yields that provide very little or, in the case of the US, negative real returns.
2012 – a look ahead
Active trading is the way to go
Having the ability to react rather than predict is still our favourite way of thinking. It is almost impossible to know what the financial landscape will look like and how deep the expected recession will be in Europe; we therefore feel that the USD will remain an attractive place to be, especially against the euro.
All eyes on Europe
Europe will continue to be the centre of the financial universe, with Germany holding all the cards. The ECB simply has to backstop the banks and print money to cap sovereign debt yields; this is what the market has demanded and it usually wins in the end. Perhaps we will get closer to fiscal unity and a eurobond. It is clear though, that Germany will not go down this road until it is staring a major catastrophe in the face.
There is a chance we could see the re-shaping of Europe, with countries that cannot get their fiscal house in order being pushed out of the 17-member European Monetary Union (EMU) and into the EU, effectively allowing them to return to their old currencies, and devalue to their heart's content. This will require changes to the Lisbon Treaty, so pay close attention to EU summits.
Potential trades in the New Year
A new US election is also scheduled, and it is highly likely that political posturing will weigh on risk assets.
We will be keeping a close vigil on the Fed to see its stance on a fresh round of asset purchases, with more than a 50% chance that this could materialise, in our view. If this were the case, we would be long gold (in USDs), while selling the USD against all G10 currencies, although AUD or NZD would outperform and one would look for equities, notably small caps to see stellar gains.
Equities will be of huge interest. They are still the only asset class offering any real value given the Fed is keeping rates on hold until 2013. Traders just need an excuse to get out of cash. Earnings visibility should clear up when we get a sense of what Europe will look like in 2012, what the level of central bank and government assistance will be, and whether China can maintain 8-9% growth. Until then, there will be scepticism about the forward earnings assumptions of companies globally, regardless of how strong they have been, and what great shape their balance sheets are.
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Updated: 01/12/2011
Disclaimer: IG Markets provides an execution-only service. The material above does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations, or an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of the above information. Consequently any person acting on it does so entirely at his or her own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. IG Markets accepts no responsibility for any use that may be made of these comments and for any consequences that result.
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