While the prospects for earnings growth in most developed equity markets are now more modest, a positive case can be made for a re-rating of equities, yet this is dependent on progress being made against some powerful headwinds.

With major government bond yields likely to stay low and below inflation, investors will continue to seek positive real returns in higher-yielding, income-generating assets and dividend-paying equities remain attractive on a total return basis.

To read Fidelity’s white paper, 2013: An event driven year, click here.

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Now this is no crystal ball gazing exercise. The aim is not just to forecast where certain economic variables are likely to be in a year’s time. Rather the focus has been to highlight trends, issues and ‘big picture’ influences that act as threats or opportunities for consumers, investors and businesses alike.

The aim has been to produce a highly readable, relatively jargon-free document. Probably today we could call this a blog. But the intention over time has been to produce commentary that causes people to think, ask the ‘so what’ question and then determine what this means for their own circumstances.

And while we have identified a range of questions or issues that should feature over 2013, really there is just one issue that is likely to dominate – how quickly will confidence be restored? To read the report, click here.

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Russell’s forecast for 2013 predicts a modestly positive, albeit volatile investment environment, noting that investors are likely to see more signs of a global recovery, driven primarily by a continuation of US and Chinese economic growth. Even so, volatility will likely remain elevated through most of the year, driven by ongoing recession and solvency fears in the eurozone.

Russell’s investment strategists discuss the following six key themes that they believe will have the greatest impact on markets and asset returns in 2013:

     1. U.S. market: Addressing long-term issues at last?
     2. Eurozone: Finding the right policy mix
     3. Global equities: A rising tide may not lift all boats equally
     4. Emerging markets: Due for outperformance
     5. Global currency outlook: More of the same, but risks aplenty
     6. Commodities: It’s not just about monetary policy

Russell has forecast since 2009 that the U.S. economy would follow a square-root shaped recovery pattern, and events have played out consistently with these expectations. For 2013, Russell’s base case scenario anticipates a continuation of this reluctant-yet-measurably-positive recovery pattern.

“Even though returns will be lower during this recovery process, we do think that they are identifiable and attainable”, said Pete Gunning, global chief investment officer, Russell Investments.

The squeeze play: Searching for real returns in a yield-starved world
On the other side of the square-root shaped recovery with real interest rates in negative territory is the reality that investors still demand a real return on their assets. In view of the dynamics of the US recovery, lingering impacts of the Global Financial Crisis and intervention by the US Federal Reserve, Russell forecasts that the net effect on investors will be that of “squeezing” them out of traditional safe-haven assets and forcing them further up the risk curve.

“Since only positive real returns build wealth, investors are forced to confront the question of what is to be done in a yield-starved world. This ‘squeeze play’ impulses people into riskier assets; we continue to advise clients to proceed purposefully and with strategic discipline,” said Gunning.

“For investors, this means attention to every detail of their portfolio management. We believe regional diversification will need to be firmly in place, as the economic center of gravity will continue to shift. As traditional investments remain flat, alternatives likely will matter more than ever. And volatility, while it certainly brings market stress, will also bring market opportunity for multi-asset, adaptively-managed portfolios,” he said.

Russell’s Core Expectations for 2013: Highlights

• The square-root shaped recovery will continue, with US economic growth of 2.1% for 2013, increasing to 2.5%-2.75% by the second half of the year.
• Tepid U.S. core inflation for the medium term at 1.9%.
• US 10-year Treasury yield at 2.15% by year-end 2013.
• Real-time indicators are not pricing in a fiscal-cliff disaster, but rather a smaller degree of fiscal drag.
• A cyclical recovery for the Chinese economy delivering GDP growth of around 8% in 2013.
• A eurozone which will remain intact, with a continuing tug-of-war between deflationary austerity and reflationary monetary policy.

Commenting on the outlook for Australia, Russell’s Global Head of Investment Strategy, Andrew Pease said the local economy would face several headwinds in 2013 and very few tailwinds as the two-speed mining driven economy merged into one at fairly mediocre speed.

“We’re now beginning to see a reversal of the rising incomes and growth supported by booming commodity prices, as evidenced in declining nominal GDP growth. For 2013, we expect real GDP growth may end up between 2.0-2.5%. Also, it’s unlikely the government will achieve its fiscal surplus target, despite pushing ahead with the largest fiscal tightening since 1970,” Pease said.

As of early December, Russell’s composite value indicator put the Australian share market at around one-quarter of a standard deviation undervalued, or 7% undervalued.

“We think the market will struggle to close this undervaluation gap during 2013, but the market will be supported by strong dividends, which are likely to provide better yields than those available through term deposit rates,” Pease concluded.

For complete findings and details on the themes and forecasts from Russell’s 2013 Annual Global Outlook, click here.

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The key points are as follows:

• While 2012 has had its fair share of worries, it has turned out far better than feared and share markets and growth assets have been able to generate strong returns for investors. This has been helped by investors looking for higher yields in the face of zero or falling cash rates.
• The combination of diminishing extreme downside risks globally, a modest pick up in growth as the year progresses and attractive valuations for most growth assets points to another year of reasonable returns in 2013. Expect interest rates to remain low globally and fall a bit further in Australia.
• The main risks relate to US budget and debt problems, a relapse in Europe, a slower than expected pick up in non-mining activity in Australia and a sharp back up in bond yields if investors get more confident.

To read this edition of Oliver’s Insights, click here.

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