The performance of almost any asset class was positive this year. It was a question of degree, driven significantly by a catch up in valuations as systemic risk was reduced. Following on from such a performance will be difficult in 2013 but the economic climate is slowly improving and the potential for disasters receding. Next year may indeed be a good year – not without its risks though.
2013 looks to be an interesting and positive- David Curmi
Let’s start with the good news. In the US, the housing market has shown some real positive sentiment – the highest since October 2006. Sales of existing homes are running at the highest in three years and estate agents are complaining about the lack of new housing stock coming onto the market. In the auto sector, sales of cars and light trucks are running at 15 per cent above 2011 and consumer confidence has risen substantially as job security returns. On the back of this third quarter, GDP was revised up to 3.1 per cent.
Meanwhile, China appears to have achieved a soft landing and the transition to the new leadership does not look like it will change the economic direction of the country. Economic growth is expected to stabilise at between seven and eight per cent in 2013.
Europe remains the sick man of the world but the potential for a disaster in Europe has reduced as the wizardry of muddling through is helping to rebuild confidence aided substantially by Mario Draghi’s various bond-buying programmes.
For the time being, these policies and actions have helped yields in European government bonds begin to converge back towards Germany’s – implying a degree of confidence that the actions taken will bear fruit. With systemic risk reduced, Europe could very slowly drag itself out of the current recession. But restructuring to make it competitive is desperately needed and serious reform in areas such as the social security and the financial system as well as progress on deleveraging at sovereign levels is an absolute must. On the positive side, labour costs are falling, especially in the periphery countries while exports are higher than pre-crisis levels in many EU countries.
Set against this background, European government bond prices are likely to struggle. If Europe stays on the current trajectory and the outcomes of the big impact events, such as the solving of the fiscal cliff, are at worst neutral, the need to and attraction of investing in 10 year German Bunds at 1.37 per cent is lost and investors will look at risk more positively.
It is unlikely that economic growth will burst higher anytime soon. Both the Fed and the ECB are giving clear signals that interest rates are not going to increase anytime soon either, especially as inflation remains in the one to two per cent range in most countries.
This scenario is positive for corporate bonds, especially sub investment grade bonds (the high yield and junk bond market). Default rates in this segment of the market remain historically low at around three per cent and investors are thirsty for yield. New issuance will therefore continue at high levels as companies take advantage of such conditions. While the major gains are over, there remains space for further good returns, perhaps in the mid to high single digits.
This scenario is also very positive for equities, with European equities perhaps better placed than their US counterparts. This is, in part, due to the fact that investor focus has been more on the US than Europe and in part due to Europe being at the epicentre of the financial storm, pushing US valuations higher. Careful consideration and identification of the stronger and higher dividend payers should be a profitable trade in 2013. As the economic picture becomes clearer, latching on a number of cyclical stocks to your strategy also looks to be a sound approach thereby plugging in more closely to the economic recovery. A shift out of some bonds may be appropriate at this point.
2013 is not without its risks though and on this front there are still a number of outcomes that could substantially impact the future. A number of these are political, as is the fiscal cliff and the various elections due in 2013, some of which could provide changes in governments which lead to different policies and possibly greater execution risk in this respect.
Others are the bigger structural changes needed to wean us off our dependence on debt to provide growth.
It can logically be argued that the growth we are witnessing is a poor outcome of the substantial sums of money being thrown at economies. In the US it is almost $1 trillion per annum. There are consequences to such actions and at some point debt needs to be paid off. Governments are therefore trying to inflate their way out of this problem. This has major implications for interest rates and therefore holding an element of gold still looks like a safe bet.
On balance, though, 2013 looks to be an interesting and positive one.
To my mind, it is not if one should be invested but in what at this point. Careful choice is likely to prove to be a key ingredient to successful performance. But remember, no action plan survives first contact with the enemy intact, therefore changes to any investment strategy will need to be made along the way. Be prepared to do this.
Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
David Curmi is managing director of Curmi and Partners Ltd.