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Investment Director’s Bulletin -
January 2012

“The need for political leadership and vision to overcome economic problems is greater than in January 2011.”

Farewell to a difficult 2011…

Global share prices rose modestly in December but this was not enough to fully recoup losses incurred earlier in the year – the MSCI World Index fell by 5.5% for 2011 as a whole. US equities strongly outperformed for the year, rising 1.4% and conversely, share prices in the eurozone tumbled 13.7% due to the eurozone sovereign debt crisis.

Meanwhile, the UK fell by a modest 1.8% while Asian markets did even worse than Europe: China, Hong Kong, India, Taiwan, Singapore and Japan all dropped by at least 16%, due to uncertainty over the economic outlook for China and India. Finally, the MSCI Emerging Markets Index ended the year down 12.7% (all sources: FactSet).

…while 2012 opens amid uncertainty and gloom

The general expectation is that 2012 will start where 2011 left off, with a global economic downturn, a lack of decisive political leadership in Europe, a potential slump in China and fears for company profits among the key risks. Therefore, the need for political leadership and vision to overcome economic problems is greater than in January 2011.

Unfortunately, the action needed from governments is even harder: requiring painful, drastic reform which will be unpopular with domestic vested interests and voters. Elections are due this year in the US, France and Russia, and in Germany during 2013. In addition, the Chinese leadership will change during 2012. All this will make it more difficult for politicians to act in the long-term national interest. A crumb of comfort is that with the consensus for 2012 so gloomy, the outcome may be better than expected!

Global growth outlook

The divergence in growth trends between the US and Europe became more marked in December. The US economy ended 2011 with a flourish with consumer confidence up and unemployment improving. By contrast, the outlook for European growth remains almost impossible to forecast, as so much depends on the success and timing of the EU governments’ negotiations to solve the eurozone sovereign debt crisis. The divergence between north and south is very stark, with Germany’s unemployment improving to a multi-year low, while Spain’s total jobless is 23%. Therefore, the risk to 2012 earnings forecasts for Europe remains firmly on the downside.

Yet many other scenarios may also surprise investors: the effects of US political wrangling or better than expected growth, a Chinese hard landing, unexpected outcomes from the Arab Spring or more successful than predicted reforms in Spain or Italy.

Support from the major central banks continues

The European Central Bank (ECB) took aggressive and proactive action in December 2011 to both ease funding constraints on banks and reduce the risk of a European bank failure through its innovative issuance of unlimited three year loans. This significant event:

• Removed the risk of a funding crisis for European banks.
• Substantially reduced fears of banks having difficulty refinancing debt owed during 2012-14.
• Gave extra time for weaker banks to strengthen their balance sheets.

Further concerted action by the world’s central banks to maintain an orderly market are likely. Yet action by the major central banks cannot alone transform the global growth outlook for 2012. For this, US and European policymakers must act decisively.

We believe the economic signals in both the US and China are hopeful. But an EU recession is looking increasingly likely and this will slow growth in 2012. However, if a global recession is avoided, shares look very cheaply priced. On a 12 month time horizon I am cautiously in favour of equities. I favour US, Asian and emerging market equities, but would not give up on European equities given attractive dividends and inexpensive valuations.

Edmund Brandt writes in his capacity as global equity strategist and investment director. His views are based on a 12 month time horizon and reflect the input from various investment teams within J.P. Morgan Asset Management. His opinions may therefore diverge from the GMAG team outlook, which is based on a three to six month time horizon and reflects the investment strategy of our Global Multi Asset Group.

Copyright © 2012 JPMorgan Chase & Co. All rights reserved.