“There is no room for complacency in 2012 but hope springs eternal”, Frédéric Buzaré, equity strategist at Dexia Asset Management, said.
The equity markets are still seeking a new valuation system at this time of an uncertain and unfavourable macro economy. The risk premium, which has been steadily rising over the past 18 months, has reached record highs that reflect extreme risk aversion on the part of investors. Investor disinterest in the equity asset class is even stronger as 2011 comes to an end.
In 2012, any rise in the equity markets will depend on changes in the risk premium. “The healthy profits of the past 3 years haven’t prevented valuation multiples contracting. All the measures and reforms designed to encourage greater financial stability should bring the risk premium down and inspire a clearly under-valued equity market,” Frédéric Buzaré, said.
Equity market outlook currently appears more binary than ever. Anything can happen on the eve of the New Year. Myriad questions have, as yet, gone unanswered (the extent of the economic slowdown in China, €-zone changes, etc…). Deleveraging processes are always long and perilous. The macro-economic context is a source of tension and uncertainty as it brings in its wake imbalances that will have to be reduced. The key to any change in the equity markets will be dependent upon the political response. The challenge lies in determining a new economic balance that will lead to greater stability. This long-term process is, although under way, as yet incomplete. In the short term, the reflation strategy (negative real interest rates, abundant liquidity) should, in theory, support the equity markets. “In 2012, as in 2011, phases of tension could lead to decisive political progress,” he added.
As well as the challenge of the deleveraging process, developing secular trends are a source of opportunity. Global economy decision-making thus continues to lean in favour of Pacific Asia, which has embarked on an enrichment process similar to that of the glorious 30’s. The confirmed depletion of fossil fuels and the increase in agricultural commodity prices are challenges for which there has not yet emerged any true appropriate response. After an under-performing 2011, an eye should be kept on the emerging countries. There should be an entry point into this zone in H2 2012.
“A certain level of prudence is still de rigueur at this year-end 2011. Recent months have taught us a lot. The extent of the crisis and the speed with which it is spreading has been collectively underestimated. Things, unfortunately, have to get worse before decisive replies are obtained. As in 2011, this sequence (deepening crisis-response) could continue, ending up in a new economic system beneficial to the equity markets. In any case, 2012 will be a binary year, in terms of both style and direction,” he said.