“Our big questions for 2013 are whether the wave of ultra-loose monetary policies and quantitative easing has crested and if private sector credit can stage a modest recovery,” says Ewen Cameron Watt, BII’s chief investment strategist. “Trillions of dollars in monetary stimulus and record low interest rates have failed to spur much credit growth and economic activity so far. But what if this changes? Policy - fiscal, monetary and regulatory - drove markets in 2012 and will remain central to 2013 outcomes,” adds Cameron Watt.
With central banks apparently refocusing monetary stimulus away from preventing a financial sector collapse and towards targeting economic growth, next steps by the US Federal Reserve will merit particularly close attention, according to the report.
“We do not expect the Fed to raise rates any time soon. But it could take its foot off the monetary accelerator on signs of quickening job growth in the second half of 2013,”says Cameron Wat. “Markets need only a whiff of a Fed preparing to slow its QE programmes because of improving employment to empty some of the vast store of investor money in cash and low-yielding fixed income assets, and put it into equities.”
In the US, much hinges on efforts to avoid the fiscal cliff, a set of tax hikes and spending cuts set to go into effect on 1 January. "The United States may turn the corner on growth – if Washington can avoid falling off the fiscal cliff and negotiate a long-term budget reduction plan,” according to the report. Regulation remains an important focus too, whether it be financial sector reform in the developed world or social security and welfare reforms in emerging economies. Politics also will play a role again in 2013 with elections in, among other nations, Italy, Germany and Israel, alongside US budget reform.
BII’s Five-Point Summary for 2013
- We have become more upbeat about the prospects for risk assets and stabilising economic growth (albeit at low levels). Low expectations = potential upside surprises.
- The US economy should gain momentum and help boost global growth – IF Washington can avoid the “fiscal cliff” and compromise on a sustainable budget.
- Many investors lack conviction in markets where risk taking is often punished and trends last a skinny minute. Rome – and confidence – was not built in a day.
- The era of ultra-loose monetary policy may draw to a close, challenging “safe” fixed income assets and heralding a shift toward equities. Safety = new tail risk.
- Income investing works in a zero-rate world – but the hunt for yield has narrowed valuations between top-quality and not-so great income assets. Take out the garbage.
So What Do I Do With My Money?
Here is a summary of the BII’s investment recommendations for 2013:
Fixed Income: Danger in Safety
Prices of safe-haven government bonds and similar assets could plunge when yields start to rise. Low yield = high price risk. We like global high yield and US munis for income – but do not expect much capital appreciation. We favour emerging market debt. In Europe, we prefer Italian and Spanish bonds over debt of weaker core countries. We are bullish on commercial mortgage-backed securities and collaterised loan obligations.
Equities: Global Smorgasbord
We like global companies with strong balance sheets, steady cash flows and growing dividends. We favour high-quality US stocks, global energy and emerging markets. We are bullish on domestic consumption plays in Brazil and China, North Asian cyclical stocks, and Mexican banks and industrials. We like discounted exporters on Europe’s periphery and small “self-help” UK companies.
Commodities: Long View
We like metals with long-term supply gaps and agricultural commodities. China’s appetite is huge.
Currencies: Dollar Bulls
We are bullish on the US dollar due to the country’s energy boom and long-term growth prospects.
Good and Bad Income
Income investing remains our strategy of choice in a zero-rate world. The hunt for yield has created pockets of overheating and narrowed valuations between top-quality and less desirable income assets. The report details the state of play in fixed income, high yield, emerging market debt, municipal bonds, dividends, and real estate investment trusts.
Our biggest contrarian idea is buying Japanese exporters while selling the yen. Other pain trades include selling “safe” tobacco stocks, buying US companies with cash piles abroad, and buying securities of European and US financials. We have warmed up to Indian equities after the country’s reforms on foreign investment.
The Gift of Insurance
Short-term implied volatility is eerily low whereas policy uncertainties are near financial crisis levels. Consider options to hedge downside and upside risks.
The fire hose of monetary liquidity and investor hunger for yield has depressed short-term volatility, so maybe a reversal will have the opposite effect.