The following article is reproduced with permission of Financial Alliance from its December market outlook which was sent to its clients recently. In November 2008, Financial Alliance (www.fa.com.sg) became the first and only Financial Adviser Firm in Singapore to achieve both the Singapore Quality Class and the People Developer status.
Highlights:
* In our view, the key risk in 2012 is that the world will slow down mush faster than we anticipate given that it’s a synchronized slowdown globally. When all major economies of the world slowing down at the same time, the likelihood is that growth will be slower than predicted. The Leading Economic Indicators are suggesting that the slowdown will continue over the next 6 months, and in all likelihood we believe it will encompass the whole of 2012.
* However, investment wise, the best opportunity will come when the market is at its bleakest. This will be somewhere in 2012 when the economic situation will be very bad. This will provide a good opportunity for investors who have a longer-term perspective.
* Investors should look to use dollar cost averaging, or in other words, break up their re-entry into equity markets into several installments. This will help to even out the volatility in markets and while it does not promise to catch the absolute bottom in markets, it normally provides a good average entry price for investments being made.
Q. What is your prognosis for 2011?
FA (Financial Alliance): 2011 started on a positive note but the party only lasted a quarter as markets reached a plateau in Q2 and then slumped sharply in Q3. The year ended above its lows but on a weak footing overall. Fundamentally, the crisis in Europe, the debt fiasco in the U.S. and an overall slowing global economy contributed to a year many investors would want to forget. While equity markets in the U.S. surprised many by closing the year relatively flat, others fared worse.
Europe was down around 13% while emerging markets as a whole was down approximately 17%. The biggest losers were the darlings of yesteryears: Brazil, Russia, India and China - collectively known as BRIC. These markets were down 18%, 13%, 21% and 17% respectively. In a nutshell, 2011 was a year which signaled the end of the 2009 recovery party which began in March that year.
Q. So what’s in store for us in 2012?
FA: The best way to look at 2012 is to consider 3 scenarios and assign probabilities to each one. By this I mean having a most probable base line scenario, a fairly probable scenario, and a low probability scenario. With respect to this, my views are:
Scenario 1 (50% probability) - Slow and low global growth. In this scenario, the global economy suffers from a slow and low level of growth as Europe falls into a recession while US growth remains low. Emerging Markets fail to pick up steam as key economies like China and India fail to pick up the slack generated by the developed countries. However, the authorities manage to do just enough to prevent their respective economies from sliding into the abyss.
Scenario 2 (40% probability) - Sharply lower and slower global growth. In this scenario, the world is tipped into a recession as some key events unfold, e.g., a further deterioration of the situation in Europe with potential defaults and even a reconfiguration of the union, a steeper than expected slowdown in China, continued political impasse in U.S. hampering progress in any serious effort to tackle the debt issues and growth slowdown.
The authorities, especially in developed countries, are seen as helpless with the limited options they have, e.g., monetary policy near zero and fiscal maneuverability impeded by high debt levels; in Europe’s case, impediments from political diversity.
Scenario 3 (10% probability) - Growth holds up. In this scenario, growth in developed countries, while not spectacular, holds up, thus creating a stabilising effect on global growth. Confidence is mended by continued support from the authorities.
Q. So effectively, one could take it that there is a 90% probability that the world will be under stress, i.e., at least slow growth with a relatively high risk of even slower growth?
FA: Yes, exactly. But this should not surprise anyone as the leading economic indicators have, over the past 6 months, been warning us of an impending slowdown.This slowdown has already taken place although it is unfolding in a non-uniform manner. For example the US is showing some trend-bucking signs of resilience, for now. Nevertheless, we still believe that it is only a matter of time before the monthly economic data across the world will all point southwards.
In our view, the key risk is that the world will slow down much faster than we anticipate given that it is a synchronised global slowdown. When all major economies of the world slow down at the same time, the likelihood is that growth will be slower than predicted. The indicators are suggesting that the slowdown will continue over the next 6 months, and in all likelihood we believe it will play out for the whole of 2012.
Q. Does that mean investors can just forget about 2012?
FA: On the contrary. I have mentioned in our October investment forum that the best opportunity will come when the market is at its bleakest. I believe that this will be somewhere in 2012. To highlight this point, let’s look at some examples.
In World War 2, the Dow actually bottomed in Q2 1942, barely 6 months after the attack on Pearl Harbor and right in the middle of a world war. Likewise, in the 1997 Asian crisis, markets bottomed out in August 2008, a year after the start of the crisis but at a time when the economic situation was still in dire straits. The same happened in the Great Recession of 2008 where markets bottomed in March 2009 amid a very negative economic backdrop. As such, just as I believe the economic situation will be very bad in 2012, this will present a good opportunity for investors who have a longer-term perspective.
Q. In that case, shouldn’t investors just buy into equities now?
FA: Even if we are confi dent that a bottom is to be found in 2012, the question is “where exactly is that bottom?”. An investor who invests at the start of the year may have to sit through a very volatile year if it turns out that the bottom is towards the end of the year. On the other hand, an investor who waits may miss out on the bottom if it takes place in the early part of the year. In essence, second guessing where the bottom might be is not advisable.
Q. What then should investors do?
FA: Investors should look to use dollar cost averaging. In other words, they should break up their re-entry to equity markets into several installments. This will help deal with the uncertainties as to where a bottom may lie in 2012. It helps to even out the volatility in markets. While it does not promise to catch the absolute bottom in the markets, it normally provides a good average entry price for investments made. In our case, the FA investment Committee is following the present situation very closely.
We are likely to re-establish our equity positions in installments over the course of 2012. Our aim would be to bring up our present equity allocation in our aggressive portfolio from the current 50:50 in equities and bonds respectively to 100:0. This will be done with corresponding changes in all our other risk portfolios.
Do note that this remains our strategy at this point, but it could change if the situation warrants it. We do not want to commit ourselves in terms of asset classes nor geographic regions to re-enter. These will depend on the situation at hand when we are about to re-enter the markets as we believe things will continue to be very fluid in the months ahead. For example, while we continue to shun European equities at this point, we cannot rule out the possibility of buying into them should a further decline make them even more attractive valuation wise.
At this point, investors should just sit tight and psychologically prepare themselves to re-enter the equity markets. It might be difficult to pull the trigger when the time comes as it will be at a time when the markets are at their darkest.
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