A positive end to the year
Global financial markets breathed a sigh of relief as lawmakers in the United States reached a last minute deal to pull the US economy back from the brink of its so-called 'fiscal cliff' and expectations for the global economy edged higher.
The deal in Washington, hammered out over the Christmas and New Year holiday period, sees Bush era tax cuts extended for the majority of taxpayers, while the automatic public spending cuts that were threatened in the absence of an agreement have been deferred for another two months, until the beginning of March. The road towards a deal has been both fractious and laboured, with negotiations exposing the inability of Congress to set aside party differences for the good of the wider economy. The failure of Congressional leaders to resolve the public spending element in the 'fiscal cliff' negotiations will prolong uncertainty about a key part of the budget outlook, leaving further scope for brinkmanship on both sides of the political divide. Nevertheless most investors appear to believe that common sense and practicality will eventually produce a settlement of this long-running issue, prompting a global 'relief rally' in many risk assets.
2012 proved to be a strong year for the contrarian investor. Unloved sectors such as banks enjoyed a strong performance in the second half of the year as fears of a breakdown in the eurozone receded, reducing the risk of a systemic banking crisis in Europe. Signs of a recovery in Chinese growth following the regime change in Beijing also helped to boost mining and other cyclical stocks, while pushing government bond yields in the UK and US higher. Contrarian strategies tend to perform well during periods of major economic turning points, so a central question going into 2013 is whether the recent return of risk appetite marks the start of a prolonged period of improvement in the economic and financial outlook, or merely a temporary turn for the better. With yields on UK gilts, US treasuries and German bunds all still trading near all time lows, there is limited potential for further capital growth, and scope for losses if the recent pick up in yields were to continue. We remain of the view that inflationary pressures will reappear in the longer term, but not yet.
Despite a gloomy economic backdrop, the FTSE 100 has broken through the 6,000 mark and is nearing two-year highs. The market's resilience is in contrast to an economy that continues to crawl along the bottom and remains over 3% below its pre-recession peak. On a more positive note, the UK appears to be holding up better than many of its eurozone counterparts. The Bank of England has forecast growth of around 1% in 2013: if correct, that implies the UK will avoid the recession that is currently afflicting most...