By: James R. Solloway, CFA, Managing Director, Senior Portfolio Manager
The Global Portfolio Strategies Group recently released its second-quarter 2012 economic outlook. A summary of its conclusions is provided below:
- Global equity markets peaked in early April and fell sharply in May, which was not a complete surprise to us. At the beginning of the quarter, we speculated that an exuberant S&P 500 Index could reverse by up to 10%. From the peak in early April, it fell by almost exactly 10% by early June.
- It could be the case that this presents a good buying opportunity, but economic and political uncertainties have intensified in the intervening months. While we are not compelled to reduce equity exposures below their strategic target weights, we do think it is better to err on the side of caution and maintain a neutral stance for now.
- We continue to favor U.S. equities over international, especially Europe. The recent European Union agreement, while a step forward, is not a game changer in our view. In contrast, the U.S. economy and financial system remain in fairly decent shape, U.S. equity valuations have declined from their recent peak, and a modestly expanding economy and moderate earnings growth bode well for a continuation of the cyclical bull market.
- Unfortunately, politics are creating a level of uncertainty in the near term that is trumping bullish U.S. fundamentals. In Europe, serious thought now needs to be given to once-unthinkable break-up scenarios. And if policymakers do not act to avert automatic tax hikes and spending cuts in 2013, the U.S. could quickly fall into recession. If there is a bull market anywhere, it is in fear. If there are asset bubbles to be found, it is in the sovereign debt of the safe-haven countries.
- The U.K. economy has felt the full force of the slumping eurozone, coming on top of domestic fiscal austerity. The government recently committed itself to additional liquidity injections and a targeted fiscal stimulus. Fortunately, inflation is finally ebbing from the stubbornly high rates of last year, providing the needed flexibility to respond more forcefully to the slowdown.
- Emerging markets have gone through a soft patch, partially owing to a triple dose of trouble, including falling trade with Europe, falling trade among emerging countries, and tighter trade credit as stressed commercial banks cut back their lending exposures. The sharp currency depreciation experienced by many emerging countries, combined with aggressive monetary policy actions, should provide a boost to these economies in the months ahead.
- Emerging market investors have faced harsh challenges during the past quarter, grappling with slowing growth and severe declines in local currencies. Emerging market equities are starting to look cheap on the basis of earnings, cash flow and dividend yields. When the “risk-on” trade comes back into vogue, we think emerging market equity could be a major beneficiary.
- As in recent summers, the investing environment has turned challenging. Market participants face a raft of uncertainties. Will the favorable market response to the latest European agreement last any longer than prior ones? How serious is the U.S. soft patch? Who will be elected in November? Will Congress jump off the fiscal cliff at the beginning of 2013? Not only is it hard to guess the answers to these questions, but it is just as hard to gauge the reaction of the markets. In this environment, we expect markets to remain choppy and news-driven going into the November elections.
Here is the full-length paper if you wish to learn more about this timely topic.