Global growth forecasts for 2012 have been revised lower. Similar to 2011, the composition of global growth will remain uneven between developed and emerging economies. But this is not another 2008.
One of the core themes in the second half of 2011 was the persistent downgrades to global growth, and therefore corporate earnings expectations. We now forecast global growth to be 2.7% (down from 3.1%) for 2012. The key observation to make is that the composition of global growth will remain very uneven. The developing economies are growing at a faster pace compared with the advanced economies.
Economic growth for the advanced economies is forecast to be 1.2% for 2012. This includes economic contraction in Europe, which is already in a recession. For the developing economies we expect growth to be 4.7% as they continue to contribute significantly to global growth in 2012. Table 1 is a summary of economic growth historically, and our forecasts.
Clearly, global growth is a significant variable that drives our local economy through a typical economic cycle. Australia is a small, open economy that is a net energy, commodity and agricultural exporter. The activity within the emerging economies will remain the key structural long-term driver for our exports. While it will not remove the shorter-term market volatility, the broader backdrop remains supportive.
Table 1: Global economic growth remains uneven
It is not all that bad, but remain cautious
Despite the significant market risks that have been building in Europe over the past year, the prospect of a global double-dip recession remains a low probability. While possible, it remains improbable given the broad global economic momentum. However, it is quite clear that Europe is already in a recession with ongoing challenges. But the emerging economies, Japan and the US all look set to contribute towards global growth in 2012. Indeed, the US data profile in recent months has continued to be upbeat and investors with exposure to US earnings have been rewarded this month. Further, the large emerging economies have significant capacity to cut interest rates and stimulate their economies further. Indeed, the market may even look to revise global growth higher by late 2012.
Valuations remain attractive
Equity valuations remain cheap on many different measures – one-year forward price to earnings (P/E), trailing P/E, price to book value (P/B), Earning Yields vs Bond Yields, etc. Of course, structural changes suggest that the long run average is too high. A multiple between current levels and the long run average will be more than enough to drive the market in the years ahead. Despite ongoing global macro challenges, value remains with quality cyclicals. Further, key defensive sectors that distribute consistent quality (and reasonable) dividends, such as telcos, utilities, and infrastructure, performed well in 2011 and will continue to perform in the first half of 2012.
The core themes to highlight in early 2012 are the various global macro challenges and the implications for portfolios. Europe has entered into a recession, the large developing economies are slowing, credit growth is stalling and business confidence has been impacted. This implies slower earnings momentum in 2012 compared with 2011. Sovereign de-leveraging looks set to continue. Therefore, anticipate lower growth ahead for 2012 and 2013.
On the positive side, global monetary policy will remain very stimulatory, and the large emerging economies have now started to stimulate with even lower rates. The recent US data profile has been very promising, corporate balance sheets broadly remain in a healthy condition compared with previous cycles (but clear challenges persist for various sectors).
A prudent way to invest
Given these challenges, a diversified portfolio with a strategic allocation across cash, fixed income, equities, A-REITs/property and alternatives remains the most prudent way to invest over the cycle for one’s ‘core’ portfolio. There remains plenty of opportunity to find value in selected investments to add to portfolio returns depending on one’s risk appetite.
Value remains in equities on a three-year-plus horizon, and going forward the correct sector and stock rotation will be key in meeting one’s expectations (that is, growth, dividend or combination strategy).
Increasingly, income will play a larger contribution to returns in 2012 for equity investors. A 5.5%-6.0% dividend (before franking) for the local market remains very attractive vs historical. On cash, it is very clear that the official Reserve Bank of Australia (RBA) Cash Rate needs to be lower in the months ahead to underpin Australian domestic demand until the global cycle re-accelerates. 2012 looks set to begin as 2011 finished.
This note was written on 20 January 2012. George Boubouras is the Head of Investment Strategy & Consulting at UBS Wealth Management.
Important information: This document contains general information and general advice only and does not constitute personal financial product advice. As such, the material does not take into account the personal investment objectives, financial situation, tax position or particular needs of any specific recipient. Prior to any investment decision, we recommend that you seek personal investment advice from your Client Advisor, based on your personal situation and consider the relevant offer document (including the product disclosure statement) before making any investment.