We are experiencing a second round of the global financial crisis, says Trevor Greetham, Director of Asset Allocation at Fidelity Worldwide Investment.
The first round was caused when banks and other highly leveraged financial institutions could not be certain of the value of complex financial instruments linked to sub-prime US housing obligations. This second round is based on uncertainty surrounding the value of eurozone sovereign debt, a far more widespread asset with a critical role as a “risk-free” asset in the global banking system. In 2008, the threat of bank runs was stopped by government intervention; now we are seeing a crisis of confidence in European sovereigns that will require equally forceful action.
Despite this, “a bullish case can be made for 2012,” says Mr Greetham. “It rests on a US-led economic upswing strong enough to offset anticipated weakness in the European economy and it assumes the worst-case scenario of a messy euro break-up can be avoided. US data has been resilient, but as things stand I am doubtful financial contagion from Europe can be avoided.
“Global growth is slowing and a peak in inflation will enable central banks to ease policy with force. However, it will be hard to offset a synchronised slowdown in the European Union, an economic area in aggregate larger than either the US or Chinese economies. Meanwhile, the ability of the US to underpin global activity is constrained by political deadlock over fiscal policy and China is unlikely to fill the gap. Its exports to the developed world are slowing and monetary easing is likely to be incremental with inflation still uncomfortably high.”
Mr Greetham says “we enter 2012 with our portfolios as defensively positioned as we were throughout 2008. One of the key reasons for my caution is I believe policy responses are making the European debt crisis worse. US investors have become used to a sequence of events that sees a market panic elicit a policy response that rapidly triggers a reversal in the business cycle and in stock prices. In earlier times, people called this the Greenspan put. But what if the policy response is the wrong policy response?
“Europe’s problems stem from a chronic lack of competitiveness in the peripheral economies resulting in large trade deficits with the core that markets are no longer willing to finance. Policy makers are addressing the crisis by insisting on ever deeper austerity, by threatening banks with injections of public capital and by hinting that countries that don’t follow the rules can leave the euro. These policies may do more harm than good.”
Mr Greetham suggests “a solution to the problem could come from a policy to rebalance the European economies with the European Central Bank (ECB) intervening to maintain market discipline in the meantime. Trying to restore competitiveness by deflating wages and asset prices in the periphery is doomed to failure when debt levels are so high. It is far better to inflate the core. If policy makers are unwilling to do this, for example by easing fiscal policy in Germany, then a much weaker euro exchange rate could do the trick by boosting German exports to the rest of the world. The ECB could help such a transition by providing unlimited support to cap yield spreads in eurozone sovereign bond markets.”
He notes “a recession in Europe will have an impact on emerging markets through trade and financial channels. European banks are the dominant lenders into Asia where credit growth has been a key driver of economic activity. Emerging markets will probably not be spared from volatility, but a weak global economy in 2012 could provide a good long-term buying opportunity in much the same way as it did in 2008/9. When global growth starts to recover, emerging markets are likely to outperform developed markets by some margin.”
As for asset allocation, “moving into 2012, we continue to favour bonds over equities. We remain underweight in commodities, albeit overweight in gold.
“Within global equity markets, we favour the US; the market has relatively defensive attributes and, despite the fiscal deadlock, it is still the most likely to stimulate its economy to protect economic growth and jobs. Economic policy is more pro-growth than in other developed markets, with the Fed willing to take aggressive action when required and the Democratic administration likely to table fiscal stimulus and housing support programs. Swiss equities are also attractive for their defensive qualities, with the currency hedged. We expect a period of euro and Swiss franc weakness and dollar appreciation.
“In summary, investment conditions remain difficult. We expect short violent economic cycles driven by bouts of unprecedented fiscal and monetary stimulus.
“Diversification across a range of asset classes will remain an attractive proposition and there will be lots of opportunities to add value through a sensible tactical asset allocation policy.”
This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information. You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product. The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.
