Gloomy backdrop will offer ‘great buying opportunities for equity investors'.
Speaking at a briefing in London yesterday, Jeremy Tigue and Ted Scott predicted the Eurozone will reach crisis point, and ultimately a climax, in early 2012 dragging both Europe and the UK back into recession.
Tigue, who manages F&C flagship Foreign & Colonial Investment Trust, believes that politics will continue to be a huge issue in 2012 with limited bold and decisive action taking place whilst some major world leaders attempt to keep voters on side in the run-up to elections - China in January, Russia in March, France in April and the US in November. In Tigue's view, the result of such political procrastination will be that the crisis in the Eurozone will rumble on with no sign of abatement, until they are ultimately forced to tackle it.
Tigue commented: "The issues in Europe have long weighed heavily on the market and we are at a point now where a decision needs to be made. An ‘end game' to this situation is inevitable; the Eurozone desperately needs to take action against a rising tide of contagion and 2012 will be make or break for them. The biggest question, to which no-one can yet guess the outcome with any conviction, is how this will play out - but something needs to happen, and soon. The three most likely options are quantitative easing, full fiscal union or a break-up of the Eurozone in its current guise. What should not be underestimated is the political commitment from the likes of Angela Merkel and Nicolas Sarkozy to keep the Eurozone going in some form. Should it collapse, it will be amidst huge acrimony."
Scott, Director, Global Strategy at F&C, believes the divergence between growth in Europe and the rest of the world, including the US, will be a continuing theme into 2012.
"What you have seen in recent months with the escalation of the crisis in Europe is that both growth and the expectation of it have plunged. It is quite likely that some Eurozone countries are already in recession. If the Eurozone, including Germany, does fall into widespread and full recession, it will probably tip the UK into recession as well, as Europe remains our largest trading partner. It also means a resolution to the crisis will be more difficult if the Eurozone continues with its current strategy of introducing structural reforms to peripheral countries to help restore growth, allied with austerity packages to improve the public balance sheets. The market is hopeful that next week's meetings in France and Brussels may herald a more decisive and bolder stance from the ECB and Eurozone leaders; however, every time there is an emergency summit, the next follows closer behind and the market has grown weary of successive meetings that have so far not led to constructive action."
Both Tigue and Scott agree that QE will likely be introduced by the ECB next year in order to preserve the Eurozone. However, Scott stresses that this does not address the lack of competitiveness in peripheral countries or the lack of growth, but merely buys more time.
QE, according to Tigue, will force bond yields up in the core countries but down in the periphery. "QE will introduce more risk of inflation, as this takes several months to filter through. In my view, bonds are fast becoming a huge credit risk - not only is there risk from default, but also the movement in the Euro. Should a country leave the Euro, this introduces currency risk. I believe that ultimately investors will be less inclined to buy bonds as 2012 progresses."
The UK has its own problems
Following Tuesday's Autumn statement, the Chancellor is still rigidly sticking to ‘Plan A' aimed at reducing the UK's huge fiscal deficit, despite the deteriorating prospects for the economy which the government's austerity measures have exacerbated. The tightrope that the coalition government has been forced to walk leaves little fiscal room for manoeuvre.
Scott commented: "Mr Osborne was correct to claim some success for undershooting the 2010/11 fiscal deficit target. However, this has been achieved through swingeing cuts in government spending despite tax revenues being lower than expected. At the same time the prospects for economic growth have fallen sharply, as lower tax receipts suggest. The Office for Budget Responsibility has downgraded its GDP expectations for 2012 from an optimistic 2.5% to 0.7% ; with the formidable headwinds of the Eurozone debt crisis and private sector de-leveraging to contend with, there is a real chance of a double-dip recession next year."
Banking crisis?
One of the biggest risks to our markets currently, in Scott's view, is a further banking crisis as a result of the ongoing issues in the Eurozone.
"I don't believe this banking crisis will be as dramatic as the last one, with banks going bust. The markets can see this coming and I anticipate that events will unfold more slowly. We could get a credit crunch, particularly with new recapitalisation rules coming in to play, in which banks are forced to rebuild their capital positions by lending less and selling assets. There is already evidence of that happening and this could exacerbate what is already a very slow growth environment."
"Tedious" markets will have to change... but opportunities remain
Tigue predicts that the constant "risk on/off" in markets looks set to continue for now but will have to change at some stage in 2012.
"There is currently no distinction between asset classes, with everything tightly correlated. With no resolution to the Eurozone crisis in sight, market conditions are likely to remain volatile and unpredictable for some time yet. When this eventually shifts, there will be a huge explosion in the dispersion of returns, which should hopefully make the market less tedious than it currently is. Despite this, at a corporate level the companies in which I am invested are still increasing their profits and dividends, and I remain cautiously optimistic for the outlook on equities in 2012."
Scott echoes this sentiment, pointing out that the ongoing Eurozone crisis and risk of recession could generate opportunities as well as risks. "Risk aversion by investors is very high, which is why safe-haven assets, such as gold and government bonds, have such paltry returns and yields. Equities, while vulnerable to a disorderly break-up in the Eurozone and a banking crisis, have discounted much of the bad news and the yield for the market is supportive. Unlike 2008-9 there should not be many dividend cuts (in the UK at least) as the financials and cyclicals are a much smaller part of the index and have already cut dividends. It is quite likely that 2012 will present a great buying opportunity for equities."
Shift in power from West to East to continue
Tigue believes that whilst the emerging markets continue to grow, the margin should be strong enough to offset any fall in Europe and indeed will create a greater divide in power between East and West than can be seen today.
"I think a tectonic shift has taken place where Europe is becoming increasingly marginalised as a global economic influence and the usual countries in Europe are going to become less and less important. I can see a situation where European countries, apart from Germany, will slip down the rankings so the G7 - the biggest economies - will be the likes of China, India and Brazil whilst France, Italy and the UK will be tail-end Charlies. I'm a bit more optimistic about emerging markets than I was a year ago, as they have had their correction. The demand story and domestic growth in these markets is still intact."
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