Expectations for stock markets next year are, perhaps surprisingly (perhaps not!) fairly upbeat. After two consecutive years of multiple compression it is tempting to believe that 2012 might see the decline arrested.
Sadly, the continuing lack of transparency surrounding the sovereign debt crisis resolution in the eurozone, ongoing concerns pertaining to the health of the US economy and fears of a Chinese hard landing have contributed to a fairly low level of conviction being applied to mildly bullish end-2012 forecasts.
Upside risk analysis
For every argument there’s a counter-argument, for every opportunity there exists a non-trivial threat. Far from opting for bold calls, investing professionals are increasingly adding weight to sensitivity analysis and the risks, both to the up and down side, to the base case.
We find much to sympathise with in this approach. Stock markets have spent the latter part of 2011 pricing in an earnings recession for 2012. Investors, as usual, have been quicker than their analytical counterparts to anticipate lower profitability but may have overshot in so doing.
Use of the word “may” is noteworthy. The opaque outlook makes holding any view with strong conviction vulnerable to inaccuracy and increasingly, public vilification in the blogosphere.
Despite official forecasts to the contrary, the UK will do very well to avoid at least a technical recession in the early part of 2012. Given the increasing likelihood that the eurozone will suffer a prolonged recession it seems hard to see how the UK can escape its clutches altogether.
We are not, for now, forecasting a recession in the US or Asia Pacific ex-Japan (although the risks have increased). This is important for the UK stock market dominated as it is by large multinational corporations the bulk of whose activities are outside Europe. This, coupled with the country’s historically high and attractive dividend yield, should provide a comparatively high degree of insulation from problems elsewhere.
Balanced portfolios
Although inflation is elevated pressures should abate over 2012. This should ensure that UK base rates remain anchored at close to zero and will likely underpin a further expansion of the Bank of England’s asset purchase programme from February. In itself this may do little to help the real economy in the near term and could, if taken in the context of concerted action elsewhere, eventually unleash a hyperinflationary genie through currency debasement. The merest hint that central banks might act in concerted fashion has helped galvanise stock markets and we might expect more of the same next year.
Investors are already positioned very defensively so any indication that strong action were being taken to forestall calamity might encourage some portfolio rotation into some of the more pro-growth sectors.
A more balanced approach to portfolio construction may be the right way to build for the challenges of 2012.
