Yet against this background, risk assets have actually performed pretty well – helped by a wave of central bank liquidity. For 2013, our central scenario could be summarised as more of the same: advanced economies still have obstacles to clear, but should manage to record positive, if below-trend, growth for the year. We see emerging markets as the relative bright spot and it is this much expanded part of the global economy that we expect to drive growth in 2013.
Growth in the advanced economies is likely to be anaemic in 2013, with potential downside risks. At the time of writing, it is still not clear what impact the US fiscal cliff will have, but even if many of the expiring tax breaks are extended, there will be a fiscal contraction in the first part of 2013 that will act as a drag on growth. In the euro area, fears of a Greek exit have subsided as attention has turned to Spain. In recent months it has avoided entering a formal bailout as the yield demanded on its sovereign debt has decreased, but with this fall driven entirely by the expectation that a bailout will be requested, markets may soon apply fresh pressure on Spain.
Emerging markets cannot completely decouple from advanced economies but growth can improve, providing Western imports at least maintain their recent pattern of stagnation. Trade within emerging markets has become increasingly important and the degree of policy flexibility is currently greater than they have enjoyed historically. The threat of a Chinese hard landing appears to have receded following stronger data in the past few months. Fiscal policy loosening seems to be already reflected in infrastructure investment and this should lead to a modest increase in growth in 2013. Brazil has also shown an improvement in growth following earlier interest rates cuts, while India has recently embarked on some much-needed reforms, which have helped to stabilise its currency and lift stock prices.
Yields on perceived safe haven government bonds such as gilts, bunds and treasuries started the year at record lows, and then proceeded to head even lower. While expensive, I believe that yields will remain low while growth is weak and central banks promise to keep short-term rates low for the foreseeable future.
However if there are any signs of more normal monetary policy on the horizon, I would expect a sharp and unpleasant increase in yields. Looking beyond ‘safe’ government bonds, earlier this year the yields on peripheral euro area bonds offered some value for those willing to take on the political risk, but president of the European Central Bank Mario Draghi’s now infamous “whatever it takes” pledge sparked a significant rally, leaving little to compensate for the risk that countries do not hit their fiscal targets.
While sovereign debt has been the focus of attention in 2012, corporate bonds have quietly produced very strong returns. Central bank liquidity actions helped, as these pushed down the yields on sovereign debt. But companies have generally been fairly prudent, and with default rates low, spreads have decreased. Arguably these now do not provide investors with much additional yield – an important consideration given that any major government bond sell-off will affect corporate bonds as well – but in a world of ultra-low yields, any pick-up can be seen as attractive.
After a volatile but profitable 2012, I expect another positive year for global equities driven by the two main factors for equity performance: earnings and valuations. A slight acceleration in global gross domestic product growth should be sufficient to deliver mid-single digit earnings growth in the next year, a reversal from 2012’s earnings decline. At the same time valuations are slightly below what I see as fair value, and loose central bank policy and investors shifting into equities looking for yield may be enough to push multiples higher.
Despite the positive macro backdrop, 2013 is likely to be another volatile year as politics remain on the agenda on both sides of the Atlantic. Recent history suggests it would be dangerous to assume Europe will not at some point be a source of volatility again in 2013, at least temporarily raising the risk premium investors demand for holding equities.
On a regional basis, I particularly like emerging market equities, given their superior growth prospects, which should help reverse this year’s underperformance. My least favourite region is the US, where equities are relatively expensive and tend to underperform rising global markets.
Tim Drayson is an economist at Legal & General Investment Management
Key points
Growth in the advanced economies is likely to be anaemic in 2013, with potential downside risks.
Yields on government bonds will remain low while growth is weak and central banks promise to keep short-term rates low for the foreseeable future.
Despite the positive macro backdrop, 2013 is likely to be another volatile year as politics remain on the agenda on both sides of the Atlantic.
