Surprises for 2012

Two thousand and eleven was the year big name investors were constantly wrong footed. Many saw their personal wealth as well as that of their clients dented as markets blindsided them. Many sought refuge in gold, but just as gold appeared to be a peerless safe haven, its value tumbled. When budget deficits seemed set to send bond yields higher in major markets such as the US and UK, bond yields fell. In other bond markets, notably the Eurozone, the reverse occurred – spreads widened to previously unimagined heights. Investing in asset markets for many became akin to a game of blind man’s bluff – nobody seemed inclined to break out in song, “I can see clearly now, the rain is gone, I can see all obstacles in my way. Gone are the dark clouds that had me blind...”  

In equity markets, the performance during January is often said to set the tone for the year ahead. Meanwhile, as January gets off to a lively start, what potential surprises can we envisage that might lurk in waiting for the unwary investor? Note that these are not forecasts per say, but events to which some degree of probability attaches, and could catch many off guard.  It is worth noting though that not all of these events are of the unhappy variety.  However, as media reports tend to define the year, media reports are likely to highlight the negative. Just as misery loves company, the media loves misery.  So certain of these events, even if they unfold, will not necessarily contextualise the headlines.

1) The reappearance of speculative bubbles, spurred on by monetary easing and ultra-low interest rates in important money centres. The billion dollar question though, is in which asset classes?  Equities, property?  It’s difficult to envisage bond yields falling much further in the UK and USA.  For fund managers the name of the game is to spot incipient speculative bubbles and float the portfolio on them for as long as is prudent, and then sacrifice a modicum of performance by hoping to time the exit from the trade before the market becomes seriously overheated. Which is far easier said than done.

2) For some time now it has seemed that central banks could expand the monetary base with impunity, without exerting a material effect on inflation.  Some attribute this to the existence of a liquidity trap. However, it has also been fairly standard doctrine for decades, backed by substantial empirical research, that a monetary shock tends to partly flow into output and partly into inflation. One does not have to subscribe to one of the extreme schools to see that it would not be entirely beyond the bounds of possibility if this relationship were to reassert itself, with surprises both in the form of stronger economic activity than expected, but also accompanied by higher rates of inflation than central banks would like or are tasked with maintaining.

3) China could experience a significant economic disruption. It never ceases to surprise me, the extent to which otherwise sophisticated investors and market analysts put their trust in some bureaucrat somewhere to provide them with the certainty the world lacks.  Currently, there is a school that has a naive and touching belief that the managers of the Chinese economy are mercifully immune from the uncertainly that bedevils the rest of us, and will somehow adroitly steer the right path for that large and complex economy.  But it is beyond anyone’s compass to do so.  In the West, investors are always seeking out the company of the senior policy makers in vogue at that time to provide them a steer on the future, while the selfsame policy makers are seeking out the company of influential market advisors who, they hope, can provide them with greater clarity on the situation as viewed from the ground.

4) Will the rest of the world economy necessarily be seriously impaired though by a substantial economic slowdown in China? China after all runs what some view as a notorious current account surplus.  China would likely try to export its way out of a slump.  This would flood world markets with cheap goods; hardly an unwelcome development for consumers. The biggest surprise could be the yuan depreciating on world currency markets, not through policy intervention, but occasioned by market forces.  

5) Currency markets might deliver a further surprise in the shape of a partial fix for the euro crisis by delivering an unexpectedly weak euro. This would provide relief for the GIPSI economies, and at the same time provide stimulus to the German economy that little needs it, with possible overheating occurring in that economy. This dynamic if it unfolds though won’t be manifest during the first half of the year; it is more probable that policy makers will first grapple with renewed recession in the Eurozone.

5) Africa could prove to be an unexpectedly dynamic economic performer.  True, this would be less of a surprise than certain of the others mentioned here, as the stirrings of vitality in that blighted continent is already apparent to many with an ear to the ground there.  The Economist ran a feature on rekindling economic dynamism in Africa last year (3 December). But awareness of this current could become more mainstream.     

6) One sometimes gets the sense that UK Prime Minister Cameron is itching to jettison his coalition partners and go it alone.  He may well feel that he could win an election outright, and feel inclined, should the opportunity present itself, to return to the polls for a mandate to govern unchecked.

7) A major medical breakthrough. For some time now, healthcare stocks have languished in the lower decile of historic valuations. Drug manufacturers continue to warn of expiring patents and a paltry new drug pipeline. But can this situation persist?  A great deal of human ingenuity is being devoted to curing the major ills of humanity, and sooner or later another breakthrough will be delivered.  But will 2012 be the year of a major announcement though?

8) A solar panel on every roof? Not quite just yet, nevertheless as prices of solar panels tumble, and technological advances yield better productivity, solar panels themselves could become far more ubiquitous.  Just as falling chip prices broadened the uptake of computers from a specialist interest to one no schoolchild could be without, so falling prices of solar panels could render solar panels the next big market phenomenon.

9) A plunge in commodity prices.  Notwithstanding a bit of a retreat in 2011, this was from nevertheless exalted values. Commodity prices continue to defy gravity; could 2012 be the year the old cycle reasserts itself and they all tumble back down? In this context, a material economic slowdown in China would have repercussions for other BRICS economies such as Brazil, as well as commodity exporters such as Australia.  

10) More untamed natural phenomena in the shape of earthquakes, violent storms, and heatwaves. But these, if they occur, are not investible phenomena in that they cannot be anticipated in time for investors to take profitable positions.   

Not all of these events can occur concomitantly of course.  For instance a slump in China and a surge in Chinese exports would likely be accompanied by a slump in commodity prices, but, equally, a faltering of Africa’s advance. And share prices of commodity orientated companies would also tumble, although others might rise, and falling commodity prices would also mollify the inflationary impulse from the monetary expansion.