The global economy saw out the final few hours of 2012 on a cliff-hanger as the world waited on some form of legislative fudge allowing the US to dodge its fiscal cliff. And a legislative fudge was what was duly delivered by Congress in the wee small hours of 1 January 2013.
The expiring session of Congress was the least productive since the 1940s, which tells you much of what you need to know about the stuttering US recovery of the last four years.
If we can derive comfort from the fiscal cliff deal, it marked the abandonment of the Hastert rule, the Republican resolution that dictated that party leaders would only allow legislation to reach a vote with ‘majority of the majority’ support: one of the biggest factors in government gridlock.
For all the sturm und drang, the fourth quarter of 2012 echoed a familiar pattern of recent years for discretionaries. After the radical reappraisal of risk appetite in Q3 on European Central Bank and Federal Reserve commitments of support for markets, Q4 saw far more limited changes to asset allocation as investors settled in.
‘This year is likely to be more of the same,’ James Calder, head of research at City Asset Management, told Wealth Manager’s Quarterly Survey, conducted over the Christmas period.
‘Investors are beginning to realise we have entered a new environment of lower growth and therefore expectations need to be tempered. The usual macro issues of Europe and other sovereigns/governments continuing to make a hash of policy [will drive returns],’ he added.
Booking US profits
Through the final quarter, investors did prudently book some profits on US equity, with overweight allocations falling 48.1% to 36.7%.
For the record, that was still a smaller margin of quarterly change than Q1 when investors piled in, and is only the fourth biggest quarter-on-quarter shift in US equity over the 21 months Wealth Manager has been surveying readers on asset allocation, so it hardly indicates panic stations.
More dramatic was the shift into European equity which was extended from Q3. The increase in overweight allocations from 25.9% to 46.7% over the three months lifted it from a 12-month low of 14.8% in Q2.
For obvious reasons, European equity allocations have been the most volatile over the period Wealth Manager has tracked them. While a large shift by the standards of other asset classes, the 20.8% Q4 change is still only the fifth largest quarterly move in European equity since Q1 2011.
Stephen Peters, analyst and multi-manager at Charles Stanley, Ben Gutteridge, Brewin Dolphin’s head of fund research, and Colin McInnes, founder of Quartet Capital, were among the opinion formers tipping European equity as one of the biggest opportunities of the year ahead.
‘We believe that quality, globally diversified companies listed on European exchanges offer the most value,’ said Paul Denley chief investment officer at SC Davies.
‘Well-managed companies based in Europe with strong international revenue streams and access to cheap debt have been relatively unaffected by events in the eurozone, but have fallen to very attractive valuations due to uncertainty and negative sentiment.’
Whatever positivity was detectable was very measured however, and risk appetite was much tempered compared to Q2. David Man, partner at RMG Wealth, said: ‘It is difficult to see enough growth to raise corporate profits to anything but sub-standard returns.’
Richard Scott of Hawksmoor added: ‘The overall environment for economic growth should improve slightly, but it is likely to remain quite fragile. The allocation within some of these asset classes is more important than the headline “over or underweight” positions. It will be a good environment for active stockpickers in most asset classes.’
That view of tempered optimism was expanded on by his colleague Daniel Lockyer: ‘It is getting harder to find value now that many asset classes have been rerated due to yields being suppressed at historic low levels.‘But we are excited about prospects for Japanese, European and emerging (including frontier) equities where valuations are attractive and only a small improvement in investor confidence is required to see a healthy rerating.’
After the rapid rebound in outlook in Q3, a similarly cool reappraisal of broader economic prospects was also evident. At the coolest end of the scale, inflation expectations basically collapsed over the three months, with the numbers expecting an increase in global inflation over the next 12 months falling from 40.7% to 3.2%, by a wide margin the lowest the survey has ever recorded versus the previous low of 34.5% in the first quarter of 2012.
Why it should do so now is a puzzle. The number of respondents predicting an increase in corporate profits also fell to a record low, falling from 33.3% to 16.1%, but breaking the record by a relatively narrower margin versus 29% in Q4 2011. A similar crash in optimism was evident across both expectations of investor sentiment and global growth.
No further to fall
Searching for positives, sentiment at least doesn’t seem to have any further to fall.
‘In 2013, we expect global growth and corporate profits to be benign, and sentiment to improve,’ said Denley. ‘However, this doesn’t necessarily imply steady stock markets and positive returns. Winter is the season for annual forecasting, but don’t believe anyone who suggests they can predict where the market will be at the end of 2013.
‘Our investment strategy focuses on value, and hence we are weighted accordingly. For example, there is significantly more value to be found in Europe than in the US, or more accurately there is more value investing in quality multinationals based in Europe versus quality multinationals based in the US.
‘In addition, there is very little, if any, value to be found in the sovereign debt of the stronger economies in the developed world, hence we own very little. Over the course of 2013, if we encounter significant volatility in equity or other markets, we are likely to adjust our allocation opportunistically, always focusing on value.’
Elsewhere on the asset allocation figures, investors appeared to recognise the end of yield compression within fixed income, with managers overweight developed world corporate debt booking a large fall, from 37% to 13.3%.
After bumping along in single digits for the first nine months of the year, the percentage of respondents reporting an overweight in developed world sovereign debt fell to zero. After briefly breaking into double digits in Q3, the number of managers overweight property slid back to 3.4%, the lowest figure since the end of 2011.
Within equity, the nearest thing to a positive consensus was in emerging markets, which managers seemed to have concluded have reached a point where its value, after several years of sideways movement, has to be recognised by the market.
Exactly half of respondents reported an overweight in the sector, versus a third neutral and 16.7% underweight.
Just over half of investors (53%) were neutrally positioned in UK equity, versus 36.7% overweight (down from 44.4% previously) and 10% neutral, also marginally down, from 14.8% in Q3.
‘The macro news continues to destroy investor confidence from time to time, but it would appear from global equity returns seen for 2012 that investors are coping with macro and volatility much better,’ said Peter Lowman, chief investment officer at Investment Quorum.
‘Indeed, many are now looking much longer-term, which is the right strategy in these difficult times.’