Top five things to watch out for in 2012

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Top five things to watch out in 2012
Time flies. 2011 had flown by in a twinkling of an eye. Nevertheless it is unlikely to be forgotten as there are several rare occurrences (or may I say, “black swan events”) in 2011. Last year saw half a dozen eurozone governments collapsing, Japan being hit by one of the five most powerful earthquakes in the world since 1900 triggering a triple disaster (tsunami, nuclear and earthquake) and U.S. losing its triple AAA standing since 1941. Thus, it is an understatement that 2011 is a dull year.
2012 has come with the S&P rising 2.7% year to date. Is it all nice and sunny from here? What are the market moving events to shape the equity market this year? Although I do not have a crystal ball, nor do I possess any form of clairvoyance, I have outlined five market moving events (not arranged in terms of importance) which investors should pay attention to in 2012.
1.      Geopolitical risks remain elevated
With reference to Figure 1, 2012 would see a flurry of elections with Taiwan commencing their Presidential Election this weekend. There is a risk that an anti China candidate winning the Taiwan presidency which is likely to dampen business confidence. South Korea’s Parliamentary Elections in April and Presidential Election in December may heighten tension between itself and North Korea. The passing of North Korea Kim Jong II likely signifies that the efforts on improving relations between North Korea and Seoul are likely to be halted as they North Korea mourns. Furthermore, it is unknown what Kim Jong Eun, Kim Jong II’s third son would do to consolidate and augment his power in North Korea. France is also having its Presidential Elections in April where the incumbent President, Nicholas Sarkozy faces competitors such as Francois Holland who has stated his intention of renegotiating the new euro-zone accord agreed by European leaders during the EU summit held last month.
Notwithstanding the above issues, existing problems in Egypt, Syria, Bahrain, Yemen, Pakistan and Iran underscore the political instability in the world that we are in.
Figure 1: List of key elections in 2012
Source: IFES Election Guide – Election Calendar, World Events Calendar
– Council on Foreign Relations, Citi Investment Research and Analysis


2.      Europe debt crisis to persist
I had mentioned in my previous write up on Europe that the European crisis is likely to worsen before it ameliorates. (see link: http://ernest15percent.com/index.php/2011/12/13/europe-finally-light-at-end-of-tunne/), With reference to Table 1 below, it is apparent that 2012 is a year of heavy refinancing requirements, especially evident in the first four months of the year. Out of Italy’s Eur375b from bonds, bills redemption, as well as coupon payments for the entire 2012, Italy has to refinance about 47% in the first four months of the year. Spain, Belgium and France have to refinance about 42%, 47% and 54% respectively. As such, it is safe to say that equity markets are likely to be on tenterhooks with such significant refinancing requirements. In addition to the bond redemptions, markets would continue to be driven by ongoing developments on the matters discussed on the EU summit on 9 Dec 2011. The ratification and finalization of the fiscal compact, targeted by Mar 2012 is a case in point.
Table 1: Bonds, bills redemption and coupon payments from 2012 – 2014
Source: Deutsche Bank; Bloomberg
Besides the avalanche of refinancing requirements, according to the European Banking Authority, European banks have to raise EUR115b to raise their core Tier 1 capital to comply with the target of 9% of risk-weighted assets by mid-2012.
Furthermore, the austerity measures undertaken by the European countries are likely to hamper growth in the eurozone. This was already evident in Europe’s recent 3Q GDP data where it only rose 0.2% q/q. According to the European Commission, they forecast the 17 nation eurozone to grow 0.5% in 2012 which was sharply lower than their May 2011 forecast of 1.8%. Most economists view a recession in the eurozone a certainty. What is not certain is the severity of the recession.


3.      U.S. – Economy and U.S. Presidential election at the forefront
U.S. equity markets have staged a solid rebound in the last quarter with S&P and Dow up by about 11% and 12% respectively. U.S economic data which have been stronger of late contributed to the recent optimism in the U.S. markets. Nevertheless, some of these stronger than expected economic data are due in part to special one off factors. For example, business spending has been greater than expected, primarily because a tax incentive for capital spending expires in Dec. As a result, some companies are bringing forward their investment into 2011.
The fiscal stimulus packages which we saw in the past few years are likely to turn into a “fiscal drag” in 2012 as U.S. tightens its budget. Furthermore, the continuous bickering between the Democrats and the Republicans over critical policy issues and budget undermine confidence. Some businesses may delay their major capital expenditure or / and hiring.
For investors, as of now, President Obama is facing a tough re-election amid weak housing sector and persistently high unemployment. Against the backdrop of an uncertain Presidential Election (which is likely to be clearer in 2H), U.S. equities may also lack clear direction in 1H.
4.      Global economy – to slow in 2012 (at least in 1H)
In addition to the U.S. Presidential Election, geopolitical risks and Europe debt issues, the global economy is likely to weaken in 1H. According to IMF, it is likely to downgrade the global growth forecast by end January which is a second time from the estimated 4% in Sep 2011. On a separate report dated in early Dec 2011, UN had also lowered its world growth forecast from 4% in 2010 to 2.6% in 2012. It issued a dire warning that the global economy is “teetering on the brink of a major downturn.”
Closer to home, it is noteworthy that Asia has not fully decoupled from the developed economies of U.S. and Europe. Europe is still the largest export market for Asia. With the ongoing Europe problems and the tough austerity measures, Europe is likely to enter into a recession in 2012 and some analysts are predicting Europe’s demand for Asia exports is likely to fall by at least 15%-20%.
Furthermore, U.S. multinational companies may be also affected even in the seemingly resilient industries such as food, tobacco, beverage and pharmaceutical etc as they do have 15-20% exposure in Europe. (See Figure 2)
Figure 2: U.S. industries’ exposure to Europe
Source: Company Data, Citi Investment Research and Analysis, Bloomberg
China is also an economy where economists fret about. The possibility of China entering into a hard landing has been debated frequently. According to Nomura, they see a one in three chance that China may have a hard landing before end 2014. Personally (although I am not an economist), I doubt China is likely to face a hard landing. However, given that Europe is China’s largest trading partner, coupled with a likely slowdown in U.S economy at least in 1H2012, China is likely to face a slowdown in its economy. Furthermore, the impact of any potential easing of China’s monetary policies (which are likely but have not happened yet, except for the first reduction of 0.5% in the bank reserve ratio since 2008) is likely to be seen in 2H. This is undoubtedly based on my premise that China is likely to have more easing measures in the next two months, perhaps as early as Chinese New Year.
5.      Horoscope – what do the signs say? Not good.
The above four matters are discussed from economic aspects. Just to provide another aspect, I have outlined the outlook for 2012 from the aspect of horoscope. According to some Fengshui experts, 2012 is a Dragon year characterized by two elements, namely Water and Earth. As Water and Earth clash against each other, this year is unlikely to be a peaceful one. 2011 is a case in point where the year of the Rabbit is accompanied by conflicting elements, viz. metal and wood. Based on the horoscope, there is a likelihood that 2012 may see some serious natural disasters such as earthquakes or / and tsunamis. It is noteworthy that some of the most serious earthquakes occurred in the years of Dragon. In addition, 2012 is year of water and earth where the Fire element is lacking. As Fire typically signifies strength in the equity market, the absence of which may indicate that market may continue to be lacklustre.
Conclusion: Volatility is there but Watch out for opportunities
Amid the various uncertain outcomes panning out from the aforementioned events, it is likely to be a year of volatility where markets may see an inflexion point in the first half of the market (probably in 1Q). Nevertheless, according to Citigroup, the earnings yield gap (a measure of equity valuations) is at the most attractive level since early 2009 and in the 1970s. Statistically, the earnings yield gap is at 2-3 standard deviations below average which typically signifies a high probability of capital appreciation in the year ahead. As one of my clients aptly put it, “stocks have value this year, hence deploy some funds, and also trading up and down a bit, and saving a good sum for the extreme volatility” This, I believe, is likely to be my strategy for the year ahead.
*P.S: I am not able to attach the table and figures in here. Email me if u want the complete writeup with figures attached.
Disclaimer
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