US equities were all over the place last year, but finished close to the starting point. Should we expect more of the same?
Or, as some doomsayers never tire of reminding us, should we get ready for that day-of-reckoning stemming from problems in Europe and fiscal imbalances in the U.S?
I don’t buy into those scenarios. In fact, I firmly believe that we entered 2012 in much better shape than in the last several years. As long as the European debt crisis and China’s soft landing remain manageable, the US stock market can move ahead.
Of course, Europe’s debt problems and questions about China’s growth are real and remain a concern. But there are reasons to believe that we will have a lot more clarity on these issues in the coming months than was the case last year.
What Will 2012 Bring?
Many of the issues that kept the market in check last year are still with us and will likely remain so through at least the first few months of the year. But I expect visibility to improve going forward, driving most of the gains for 2012.
Recessionary worries about the U.S. have eased, with the economy expected to grow a little over 2% in 2012. It is hard to get excited over that level of growth. But a 2% growth pace starts looking a lot more attractive relative to the outlook for the other major developed economies.
Importantly, this is plenty of growth for the corporate sector to sustain its profitability momentum. With the fourth quarter earnings season just getting into high gear, it is expected to show a lower growth rate than what we have become accustomed to in the last two-plus years. But that shouldn’t be much of a worry given where we are in the earnings cycle. With margins effectively at peak levels and top-line gains getting hard to come by due to the relatively softer global economic backdrop, growth rates were bound to come down. And they have.
Although US stocks are likely to generate gains in excess of +10% from current levels this year, I am not expecting a nice straight up move in 2012. In fact, I envision two distinct phases in the stock market this year, with each requiring its own set of investment strategies.
More of the Same in Phase 1
In the first phase, last year’s concerns carry over into 2012 are likely to last through the spring months. During this period, the market essentially behaves the way it has over the last few months, with worries about European and Chinese growth as the key headwinds.
I believe that Europe builds on last month’s EU agreement and continues to move towards greater fiscal integration. I expect the coming months to bring more clarity on the next steps in that evolution, where the European Central Bank [ECB] becomes the lender of last resort (like the U.S. Fed) and meaningful progress gets made towards the issuance of euro-bonds. Europe still goes into recession in 2012 under the weight of the tough austerity measures put in place, but the fear of the union imploding eases.
I have a fairly positive view of the ongoing Chinese slowdown. I feel that current fears of a hard-landing for the Chinese economy are overblown. A combination of fiscal and monetary easing by the Chinese authorities will ensure steady economic growth in that country. We should start seeing evidence of that by the middle of the year.
Increased Visibility in Phase 2
Increased visibility about Europe and the extent of the Chinese slowdown should help remove the clouds that have been weighing on the market in the phase 1.
Please note that I am not calling for an end to Europe’s debt problems or the region becoming an engine of growth for the global economy. I expect Europe to remain a drag on global growth in 2012 and take years to work off its fiscal excesses. It is the removal of the current threat to the currency union that lets the market breath normally.
In the US a GDP growth rate in the 2% vicinity this year is likely. Election-year rhetoric is harmless to this growth rate given continued momentum on the corporate investments front, an improving labor market helping consumer spending, and housing being less of a drag.
Making It Work for You
I am not looking for much US stock market momentum in the first phase, with most of the year’s gains coming in the second phase. While it’s difficult to be precise about the timeframes for these two phases, I am reasonably confident about the idea of two distinct market phases this year. But this leaves us with the question of how to build a winning portfolio to execute this outlook.
In 2012 AVC Advisory is launching an ETF Guide to provide investors with a monthly look at which markets and internal sectors are showing strength. It will contain portfolio allocation models that can be tracked and followed by self investors and financial advisors alike. The sector focus will be on the US market, but will also include bonds, commodities. With closer guidance through trackable allocation models, investors can easily following the shorter term trends that have ruled the stock market recently.