For equity investors, the last five years have been anything but boring. In 2008 they had the Great Crisis and in 2009-2010 the Great Recovery. So far, so good. Since mid-2010, however, the investment environment has changed. In the difficult global economic scenario, the monetary policy decisions of central banks have become the main guide for investors, even more decisive than corporate profits. The economic cycle has shortened, starting to follow the pace of liquidity injections decided by central banks. The ups and downs generally did not last more than six months. And throughout this period, interest rates have fallen steadily, eventually becoming negative in real terms.
As a result, equity markets have been driven more by liquidity than by earnings, which is particularly evident when comparing 2012 with the previous year. Indeed, for much of 2011 corporate earnings surprised to the upside, but stock prices still fell as ECB policy surprised to the downside. In 2012, however, exactly the opposite happened! When the Fed and ECB made clear their willingness to support the economy at all costs, the risk of a deflationary scenario in Japan clearly diminished. And in Japan itself there are many calls for the adoption of a more aggressive approach to combating deflation.
This combination of very low bond yields and low systemic risk is undeniably a positive for risky asset classes that still offer an attractive yield. These include equities, real estate, emerging market debt and high yield bonds. While many market participants are still overly optimistic about earnings growth in 2013 (we expect growth of no more than a few percentage points), the generally positive outlook on these asset classes is therefore understandable.
Nonetheless, some very important questions remain: the fear of central bank misdirection appears to have diminished, but the same cannot (yet) be said for governments. In the United States, for example, it can still cause volatility, as well as the upcoming elections in Italy and Germany. Well we are witnessing a recovery of the economic cycle in the United States and Asia, the doubt still remains that it is just another six-monthly swing of the pendulum and nothing more, in line with the brevity of the economic cycles of recent years. In our view, the likelihood of the current global recovery lasting longer than previous ones has increased recently, amid a more stable political environment. However, equity investors should not hope for a substantial economic recovery anytime soon, as such an eventuality would fuel fears of an end to accommodative monetary policy in 2014. And, as a result, the effect of an increase in expected corporate earnings could be nullified . In an environment where risky assets are driven by liquidity, equities have the greatest potential for a decent return in 2013, with a world economy that, without major disruptions, will struggle but calmly. Sometimes, maybe it's better to be bored.
