As a result, the required ongoing adjustments in fiscal positions have been able to take place at a measured pace. Next year, then, will be all about how economies adjust and the interplay between growth and greater fiscal conservatism.
While headlines over the ‘fiscal cliff’ dominate in the short term in the US, we believe that pragmatism will prevail and the necessary fiscal tightening will be offset by growth in the private sector. This is most evident in areas such as the housing market: after several years of extremely weak activity the inventory of unsold homes has cleared. New houses are being built and property prices are beginning to rise.
The Federal Reserve has vowed to remain as accommodative as possible. In an unprecedented move, it recently declared that interest rates would remain on hold until unemployment fell below 6.5% (it currently sits at 7.7%). With the banking system also in reasonable health, the US should continue to provide a modest tail-wind for the rest of the world.
In the UK and eurozone, the requirements for fiscal adjustment are also onerous. For the UK, the historical profligacy of government spending is a notable ongoing challenge, with only the actions of the Bank of England ensuring that the cost of prior misdemeanours is low. This, though, is being offset by greater flexibility of the private sector, which should provide a source of growth and investment returns in 2013 and beyond.
In mainland Europe, there is a notable mixture of outcomes. These range from the deep, austerity-driven adjustments in Spain and Ireland, to the greater focus on preserving the status quo in France. With Germany remaining a bedrock and the ongoing policies of the European Central Bank, we would suggest that crisis conditions can be kept on the back burner.
However, the normalisation in government financing costs does not necessarily equate to greater borrowing in the private sector. Due to a combination of a reluctance to lend and an unwillingness to borrow, weak credit growth will likely ensure that the amplitude of any recovery will be paltry by historical standards.
Putting this together, we forecast moderate growth in 2013. This will see stronger growth in the US and continuing superior GDP growth in the emerging economies dragging up the UK and Europe. That said, we do not anticipate a tide to lift all boats and following the sharp rises in various markets in 2012, returns from equities will be more selective and stock-specific.
How have we played this in our portfolios? First, we have increased our weightings in financials, with more emphasis towards North America. The ongoing recovery in the nation’s housing market and corporate self-help should see returns improve. Dividend payout ratios for US financials also have scope to rise, making prospective yield-based valuations attractive. We have reduced our exposure to defensive sectors, which look relatively expensive across all regions.
William Low is director of equities at SWIP
