Economic outlook remains uncertain

The outlook for 2012 is highly uncertain, with the potential outcomes unusually split between disaster and safety, perhaps now more so than at any other time in recent history, according to Percival Stanion, head of asset allocation at Barings.

Commenting on the year ahead, he said: “While we continue to attach only a relatively small probability to a global double dip recession, the ultimate outcome of the current troubled world economy will be messy and we therefore expect markets to remain susceptible to sudden swings in investor sentiment.

“On a general level, we are closely monitoring developments in Europe, China and the US as these economies will be the key determinants of the investment landscape in 2012.

“The key risk for investors remains the eurozone debt crisis, and its subsequent impact on the banking sector and the availability of credit. We expect European leaders to do enough to stave off a collapse of the banking sector, but the fiscal squeeze will continue and recession in Europe and the UK now looks certain.”

While the likes of Greece, Spain and Italy have dominated the headlines, Stanion believes that France will increasingly find itself in the spotlight in 2012. He believes that France has entered a state of ‘sub-sovereign debt denial’ and with no central bank, France’s government does not have the mechanism to buy French sovereign bonds, in effect becoming little more than a local authority at the mercy of the European Central Bank.

Stanion said: “Greece, which has already been in a recession for the past four years, will continue to suffer for the foreseeable future and may ultimately leave the eurozone, with the possibility of Italy and other southern members following.

“We believe that the Greek and Italian technocratic governments will also likely be replaced in the short term as enforced austerity policies remain deeply unpopular and social unrest snowballs. However, we expect the core of the eurozone to stay together, at least for the next year, and there should be no dramatic implosion even if weaker parts are brushed off.”

He believes that the prospects for the US economy are more positive.  “This is highlighted by generally better-than-expected recent economic data releases – and the outlook is for modest growth over 2012,” he said. “In this regard, it is important to recognise that the US enjoys several huge benefits over Europe, namely an integrated policy formation process via one national government, a pragmatic central bank, and a willingness to suffer short-term pain through wage cuts, or redeployment of labour, that will restore competitiveness.

“Consumer spending remains resilient supported by employment growth. Corporate spending could increase with more capital expenditure spending in 2012. Overall, the current earnings growth rate in the US is better than anywhere else in the world.”

Elsewhere, Percival believes that the emerging world looks vulnerable to a sharp slowdown in exports and a contraction in credit availability as the European banking sector shrinks its balance sheet.  He said: “While policymakers still have policy tools that could turn things around later in 2012, the short-term trajectory is now likely to be significantly lower. We are also concerned that investors seem to have pinned their hopes on the People’s Bank of China implementing the perfect policy mix to successfully engineer an economic ‘soft landing’ for Asia’s largest economy.

“The Chinese Government has yet to pursue an aggressive stimulus package and although reserve requirement ratios have been reduced, Chinese GDP should bottom out in the first quarter of 2012, with growth rates widely expected to drop below 8%. In our view, it will be a few months before China becomes a good buying opportunity again.

“In 2012, Russia could potentially prove to be an attractive option, although this depends on the results of the impending presidential election. Firm oil prices have allowed Russia to insulate itself from the rest of the eurozone and this should mean good opportunities for equities towards the second quarter, assuming the political situation remains stable.

“Korea and Taiwan, which rely heavily on the direction of the global economy, could also present good opportunities later in 2012, once the eurozone debt situation becomes clearer.

He concluded: “A further decline in valuations, or meaningful progress on the eurozone debt crisis, would lead us to become more positive on equities, but we are currently content to keep risk down at minimal levels given the uncertainties facing the global economy.

Sometime next year will represent a great buying opportunity for risk assets - or earlier if Germany relents and allows the ECB to increase its programme of buying European government bonds.

“As policy stimulus comes onto the agenda in China and other emerging economies, we may also be inclined to look more favourably on those markets.