In fact, in dollar terms, the S&P 500 index produced a positive total return of 2.1% – hardly a disastrous year.
Since 2008, the global economy has benefitted from a huge monetary stimulus in the shape of ultra low interest rates and quantitative easing.
However, the other side of the coin has been weak growth, fiscal tightening and the fear of sovereign defaults in Europe. The lack of a clear resolution to the underlying fundamental problems in Europe has increased investor nerves and raised risk premiums across most asset classes, making the underlying problems even more acute.
The side effect of this risk aversion has been the performance of so-called safe havens – most developed market government bonds, certain currencies (dollar, sterling and yen) and to a certain extent gold.
Unfortunately, some safe havens (such as the Swiss franc) fell by the wayside and gold was subject to high volatility, making it increasingly difficult for investors trying to eliminate risk for their portfolios.
Funding relief
At the beginning of 2012, the macro issues remain much the same, although the new three-year funding programme instigated by the ECB does offer some hint of relief.
The €489bn of funding provided to European banks in December does now appear to be having a positive effect and it is expected that the second round of funding on 29 February will be yet more beneficial.
It is hoped that European banks will use this cash, for which they are paying an interest rate of 1%, to invest in higher yielding European government bonds and bills.
This may seem to be an ambitious objective, given that banks spent most of the 2nd half of 2011 selling down such exposure to reassure markets of the quality of their balance sheets. However, there are now clear signs of relief in some of the worst affected sovereign markets with bond auctions being well supported at significantly lower levels than seen during the final quarter of 2011.
Those investors who sought out safe havens in 2011 need to be aware of the potential significant downside risk in these asset classes. For example, yesterday (1 February) the FTSE UK Gilts Allstocks Yield was 2.5% compared to the UK RPI rate of 4.8%.
No real yield
Even if the Bank of England is correct in its prediction of a fall in inflation down to 2% by the end of 2013, there will still be no real yield offered by gilts at current yields, which would make them look very expensive in a historical context.
If the markets suddenly demanded a ‘normal’ real return (of say 2-3%) then gilt prices could fall substantially. The same would obviously apply to index linked gilts where real yields are negative and, in general, sensitivity to rises in yields is even greater.
These trends could be accelerated by a reassessment of sterling as a safe haven. The UK economy is stagnating. The state of the retail sector was highlighted by the extent of the disappointment with the Christmas trading figures for Tesco.
Unfortunately weaker growth will place an even larger question mark against the government’s fiscal austerity plan and raise the clamour for a plan ‘B’. Industrial output is weakening and the trade deficit is still increasing – not normally a positive background for a currency.
Jeff Keen is manager of Waverton Global Bond Fund
