One of the key consequences of 2011, with its series of major events and crises, may well be that investors have to operate against a background of elevated risk premia for some time as there is little prospect of one of the key sources of uncertainty, namely politics, resolving itself before the end of 2012.
We therefore expect the coming year to be characterised by more of the same as markets struggle to transition to a new return environment that, one day, may be regarded as normal.
In the face of this continued volatility and elevated risk premia, we are lengthening rather than shortening time horizons to take advantage of investment rather than trading opportunities. For long-term investors, valuations may be a driver on which they should place more emphasis to help steer them through this uncertain period of transition.
As a result we remain cautiously positioned, focused on sustainable yield opportunities. We still expect the business sector to deliver earnings growth of around 5-6% globally this year. Our analysis indicates a noticeable decline in top line revenues, but given the strong control of labour, interest, tax and depreciation costs we forecast margins can be maintained around current levels.
Hence, portfolios remain heavy in corporate bonds, real estate and selective equity markets, albeit while monitoring the risks from a global or regional recession. Government bond positions are broadly neutral.
We expect Europe, Australia and emerging market central banks to cut rates further in coming months. In addition, further QE programmes will encourage flatten yield curves in several countries and underpin highly-rated bond markets.
Short-term triggers to add to equity positions would include firmer signs that emerging market economies are looking to ease monetary policy, much lower commodity prices providing a boost to consumer and corporate incomes, or clearer signs that the hefty political risk premium weighing heavily on developed equity markets is starting to lift.
Recession risks still need to be monitored carefully, in an environment where many risk assets are cheap, but not ultra-cheap, on long-term measures.
