Published: March 01, 2012
Cash, like all other asset classes, is bound to the health of the wider economic environment in which it exists. In recent years, during which we have seen prolonged periods of broad market instability and heightened risk aversion even at the ‘risk-free’ end of the investing spectrum, cash on corporations’ balance sheets has risen to record levels and the emphasis for treasury departments has remained firmly on capital preservation and liquidity. Will this environment remain the status quo for some time to come as global economies slowly grind out economic recovery or could it be that recovery is just around the corner?
Whether recovery comes sooner or later, we thought it provoking to highlight what senior investment leaders across asset classes at BlackRock considered to be the main themes for this year. Will 2012 be a re-run of 2011 or will we experience something quite different?
In the extract below from BlackRock’s Investment Institute report The Year of Living Divergently, senior portfolio managers and leaders at the firm step back and consider the likely macro-economic and investment themes for 2012.
“What lies ahead in 2012 for financial markets? A time when emerging economies and asset prices finally come into their own? A descent into an investment nuclear winter? A re-run of 2011, with rudderless, ‘risk-on/risk-off’ market forces sidelining many investors? Or a sunny upland where policymakers pull the right levers and growth abounds? We believe we are at an inflection point for economics, asset prices and risk appetite. Signs are everywhere: the euro debt crisis looks to come to a head, China and other emerging markets are easing monetary policy to regain growth momentum and the US economy is showing tentative signs of improvement.
We are likely to see a 2012 investing landscape that is very different from last year’s environment of assets moving in lockstep. We have sketched out scenarios of how things could pan out this year, providing a framework for investors to take advantage of new opportunities and to guard against risks.
We see an increasing divergence between faster-growing emerging markets and the debt-ridden developed world. The ‘real’ economies and asset prices will likely decouple, helped by emerging markets having the room and cash to stimulate growth. In this ‘Divergence’ scenario, Europe is expected to have a recession followed by a snaillike recovery in 2013. The US economy and Japan muddle through.
The biggest risk is the European debt crisis spins out of control and plunges Europe into a deep recession that spreads to the rest of the world. This ‘Nemesis’ scenario – named after the Greek goddess who punishes the proud – would be bad because the developed world has little firepower left to fight another crisis.[[[PAGE]]]
We see Divergence as our main, most probable scenario. The odds for Nemesis are much lower, but still uncomfortably high. Markets have not factored in either scenario, creating opportunities for smart investors. Other scenarios are: the current stagnation continues, inflation surges or global growth resumes.
There are big questions this year. Can policymakers pull back the Eurozone from the brink? Will China be able to re-accelerate growth? Will smart monetary and fiscal policies offset the effect of global banks’ shedding assets? Is the US economy’s recent strength sustainable? The answers to these questions are signposts, and we want to see them clearly before we fully commit ourselves to taking a particular route.
In Divergence, we would like equities, investment-grade and high-yield bonds, and metals including gold. We would expect poor returns for safe-haven government bonds, the US dollar and the euro. Within equities, we would focus on emerging markets, and the energy and resources sectors. We would favour most alternative investments. The usual suspects of cash and US, German and Japanese government bonds would dominate in Nemesis. Gold may also work. We would hold US dollars and prefer the yen to the euro. Alternative investments may offer protection – if they can stomach a short-term funding crunch. Within equities, we would like Asia and US defensive stocks while avoiding Europe.
We believe inflation is unlikely in 2012. One caveat: pretty much everybody backs this idea, and conventional wisdom is often upended. Global monetary easing or another run-up in commodities prices could conceivably spur inflation. Market prices reflect the consensus view, so there are risks.
Eventually, we expect a move to sustainable global economic growth at just above historical trends. The question is how we will get there and how fast. In the meantime, markets will be volatile, magnified by elections in key countries. Investors will hunt for safe income in a risky world with low interest rates. And cash will be an important tool to hedge against Nemesis and exploit short-term opportunities.”
(click above image to enlarge)
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