The end of 2011 pretty much mirrored the general sentiments of the second part of the year, with uncertainty and volatility reigning supreme.
The European Sovereign Debt crisis once again dominated headlines. December was being seen as a make or break month and the most important in the history of the European Union. The outcome of which was more indecision and lack of clarity. European leaders did unite to reform and improve the Maastricht Treaty –all except David Cameron and the UK- however markets initially reacted unfavourably with both the FTSE & EuroStoxx indices declining. The treaty reforms seemed to have defined the end game of closer fiscal union and tighter budget controls, without giving clear and credible solutions in the shorter term. The main reason for not satisfying global markets and investors was the ECB; who didn’t commit to greater government bond purchases and increasing their power as lender of last resort. What was agreed were automatic sanctions for countries exceeding the 3% of GDP deficit levels and to increase the bailout fund by an additional €200bn.
Growth in the Eurozone remains sluggish at best, with increasing unemployment and fast falling manufacturing growth, however the ECB did cut rates by a further 25bp to 1% this month, in a bid to add stimulus and control bond yields. European Cost of borrowing was again hit in early December when 15 Eurozone nations were placed on credit watch by S&P. This further increased yields and was seen by some people as reckless in timing. Eurozone bonds continued with high volatility ebbing and flowing for the rest of the month with Italy once again a loser, ending with unsustainable yields of over 7%. The value of the Euro has also been hit, falling to an 11 month low versus the dollar to around $1.30.
Despite the grim economic forecasts for growth, lacklustre consumption and record unemployment figures, December was a ‘relatively’ successful month for the UK. Bond yields had decreased to around the 2% level, reducing the UK’s overall cost of borrowing. The FTSE recovered from a large drop in mid-December -after the uncertainty of opting out of the treaty reforms- to par the month around the 5575 level. Inflation has started to ease -down 20bp to 4.8%- and the UK deficit had narrowed further than was predicted. Interest Rates changes and further increases to Quantitative Easing were both voted unanimously against by the Bank of England. In light of the further troubles in Europe, the UK was beginning to become a safe-haven for Investors.
The US has also re-affirmed its perceived position as a safe haven over the month of December as Investors pursuing risk-off strategies fled to dollar and dollar denominated assets. The greenback has increased 8.7% -versus a basket of currencies- whilst bonds have returned 4.4% and equities have rallied up 1.7%, with the S&P closing the month around 1,260 and the Dow Jones at 12,250. In addition, the US has posted strong economic figures. Manufacturing has increased to its strongest levels since June and Unemployment levels are also falling, generating a new air of positivity in America. In the shorter term -until a clear solution to Europe is met- we expect this flight to quality to continue.
Asian markets however seem to have been the main loser in the Risk-off December with the Nikkei225 down 8,450 from 8,581 and the Hang Seng down 806points to 18,434; as investors continue to reach for safety. The region has also posted inferior Economic data with declines in Japanese and Chinese exports leading to growth figures revised south; by 30bp to 7.2%. In addition, the death of North Korean leader Kim Jong-Il has thrown a certain amount of uncertainty into the region.
With respect to asset classes, in the Fixed Income space, as mentioned, Gilts have continued to rally. This again re-enforces our view that they are massively over-price, and remain something to avoid. European debt, despite yielding much higher returns is still far too risky. Going forward, our preferred option in this area is High Yield and we continue to monitor the situation with regards to the best point of entry.
On the property front, despite articles claiming the UK market has been ‘surprisingly resilient’, our views remain staunch. With sluggish growth, interest rates only ever going in one direction and demise of the high street painting a bleary picture for retail property; the outlook continues to be unfavourable. We do however continue to like Asian property and believe this will see growth over the short to medium term.
In conclusion, December has been a wholly unsatisfying month with regards to Europe and has only fanned the flames of uncertainty. Going forward we do believe a resolution will be found, but being able to pin some sort of time frame for a satisfactory conclusion is anyone’s guess. Short term tensions will occur but more general, positive incremental changes should also be experienced. We expect to see continued flights to quality in the early part of 2012 with the US being a particular winner.
