Friday, December 14, 2012

2012 in review

What a year that was.  We started 2012 picking that three broad themes would dominate markets: the Euro zone debt crisis, the pace of economic growth in America and whether the China slowdown would be “hard” or “soft”.  We weren’t disappointed.
We took a considered but ultimately constructive view on each.  Now here we are at the end of the year with the Euro zone still intact and Greece still a member of the club, America having avoided recession and, while growth in China slowed more than we initially thought, it appears to have averted a hard landing.
If I was to sum up the year in two words they would be “crisis averted”.  That’s a tad risky given that as I write there is still one potential crisis playing out: the US fiscal cliff.  Our view is we will most likely end the year with some components of the fiscal landscape decided on, but others kicked down the road.  I think there’s some risk of complete failure in the negotiations and the US falling off the cliff, but I’d give that a low probability.  No one wants to be blamed for tipping the economy into recession.  I imagine that’s a strong incentive for a positive outcome.
Central banks have played a key role over the year.  That’s important because no-one else has.  The US Federal Reserve has continued to provide liquidity and is now in an environment of open-ended quantitative easing.  The ECB finally stepped up as lender of last resort in the Euro zone but in a smart way by tying countries that ask for assistance to fiscal and structural conditionality.  The Bank of England and The Bank of Japan both stepped up unconventional easing programs with only the BOJ able to be accused of not doing enough to meet its new (positive) inflation target.
For the first time in what seems like many years I’m heading into Christmas thinking that global risks are abating rather than rising.  There’s still a lot of work to do. Europe may now have a somewhat more robust framework for dealing with the sovereign debt crisis and finally a lender of last resort in the ECB, but macro-economic stability and long-term fiscal/financial sustainability is still a work-in-progress.
Underlying economic fundamentals are improving in America which makes it better able to wear a bit more fiscal contraction in 2013.  In China indications are that the recent slowdown in growth bottomed-out in the third quarter of 2012.  The slowdown had both cyclical and structural elements.  In the end it was more structural than cyclical by virtue of the fact the authorities were quite happy to see the economy slow after the excesses of the post-GFC stimulus program. We expect annual GDP growth blipped higher into the fourth quarter of the year, but we continue to believe the recovery in growth will remain modest.
At home we weren’t disappointed with our view that growth would remain hard work in New Zealand.  The first half of the year exceeded expectation, but the second half is proving to be more challenging.  The combined headwinds of household deleveraging, fiscal contraction and the high New Zealand dollar will continue to make the going tough.
As the various potential crises have played out markets have been volatile.  However, well-diversified multi-sector portfolios have performed well, at least compared to the prognostications of some media headlines (and even some reputable economists) of imminent global economic catastrophe at certain points through-out the year.
Next year we will continue the voyage of discovery into the ethereal concept of the “new normal”.  That journey will still be challenging and it will no doubt continue to have its ups and downs, but hopefully not the same degree of angst.   Next week:  Ten things to watch out for in 2013.