Market Commentary - 2012 - Quarter 4 January 2013

Market Commentary - 2012 - Quarter 4

We started the quarter with more concerns about the outcome of debt negotiations in Europe and further uncertainty about regime change in the US, China and Japan, yet despite all this, the performance of stock markets around the world was broadly positive. This has been mainly driven by the recent release of political pressure in Europe following Greek debt restructuring and the ECB supporting the bond markets in the rest of peripheral Europe. In the US economic data has been encouraging and political uncertainty has been settled; even the fiscal cliff has been resolved in the first few days 0f 2013. Lastly the Chinese hard landing and regime change has come through its critical phases without damaging market confidence significantly.

The last quarter of the year was much less volatile than the first half of the year because of the reduction in what have been termed “ tail risks” – those risks that have a small probability of occurring but if they did would drive markets significantly downwards. Political statements and central bank action in September and October helped to stabilise market levels around the world and, in particular, those that had been operating on very weak valuations such as Europe. Europe has had a very strong year despite fundamental data not being significantly better than earlier in the year.

Economic opinion on the next year or so leads us to the consensus view of a slower growth world although this is not constant across either countries or sectors. The world can be broadly split between two groups. The first is where de-leveraging pressures are intense and includes European sovereigns and their banks. The second group, which is not so challenged, includes much of the corporate sector, US banks, the US consumer and emerging economies. This means that although overall growth may be muted there will be areas which continue to push the global economy forward.

Looking at this in a longer term context, we can consider how our economic environment has changed over the last few decades and how this now affects the current investor’s mind set. The financial environment or investment regime typically drives returns from the different asset classes. Much of the seventies were dominated by stagflation, which was a poor environment for both equities and bonds. The eighties and nineties, now often referred to as the ‘Great Moderation’ was a disinflationary environment positive for both equities and bonds. From 2000, increased levels of leverage drove returns until the bubble burst with the financial crisis. Since 2009 the world has been in de-leveraging mode. The world, as noted, has been dominated by event risk due to this deleveraging. This is a difficult environment in which to invest. To succeed, investors need to understand the financial environment on a longer term basis.  Furthermore a more active approach to asset allocation and stock selection than was the case in the ‘Great Moderation’ is necessary to deliver above average returns.

Market commentary provided by Rayner Spencer Mills – Quarter 4 2012

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