December 19, 2011

Outlook 2012: Global Economy View—J.P. Morgan, LPL, S&P

J.P. Morgan Funds strategist David Kelly is overweight equities, underweight fixed income

With advisors struggling daily to keep up with current events in the European debt crisis, they continue to assess what these changes will do to their clients’ portfolios.

An understanding of where the global markets are headed in 2012 will certainly help nervous investors decide where to put their money. As a result, just about every economic commentator is focused on Europe (not to mention the U.S. budget mess in Washington) in year-end outlooks for 2012.

So where exactly is the troubled eurozone headed? The honest answer is that nobody really knows, which explains why analysts and market participants are watching the news out of Europe so closely. For the moment, the Federal Reserve has joined with five other central banks to lower the cost of dollar funding and the European Central Bank has dropped its key interest rate and is planning to lend banks as much money as they need for the next three years.

Looking ahead to 2012, market strategists and portfolio managers are combing through the data in a search for investment opportunities next year. Here’s what the experts are saying:

J.P. Morgan Funds Chief Market Strategist David KellyJ.P. Morgan Funds Chief Market Strategist David Kelly (left) said in a Nov. 29 conference call that Europe “is very far from the end game,” and more recently, in a Dec. 5 note, wrote that stocks generally look cheap around the world and U.S. Treasuries, Japanese government bonds and German Bunds look expensive. Not surprisingly, Kelly is overweight equities and underweight fixed income.

Throughout this year, he wrote, markets have been volatile in response to two extremes: “an extreme in valuations and an extreme in uncertainty.”

Kelly didn’t fail to mention on the call that even as Europe is struggling, the United States is bringing its own problems of political economy to the investment table. “The single biggest threat to the U.S. economy is the decisions that Congress needs to make before the end of the year,” he said.

While current events may provide an opportunity for long-term investors, it is important to remain balanced for a number of reasons, Kelly wrote: “First, with growth apparently turning negative in Europe and slowing down in emerging markets, the global economy is losing steam. In such a situation, it is never clear quite where the bottom is. Second, while policy-makers in Europe and the U.S. have the opportunity to make some good decisions over the next two weeks they certainly also have the opportunity to make further bad ones.”

Even though there has been a pickup in the United States, companies in fourth-quarter 2011 have faced headwinds from a slowdown in global economies, some in the emerging markets but especially Europe. The U.S. dollar is higher, driving inflation up in the States and hurting foreign profits, said Kelly, adding that U.S. stocks are decoupling from European stocks.

“Going into 2012, we need to reassure investors with the things that we know how to reassure them about,” Kelly said on the call. “But people should not head for cash. Cash is paying them zero, and it will cost them in the long run.”

LPL Financial Chief Market Strategist Jeff KleintopLPL Financial Chief Market Strategist Jeff Kleintop believes that the European debt dilemma and the U.S. presidential elections will hold “meaningful consequences” for investors in 2012.

In his 2012 market outlook, “Meeting in the Middle,” Kleintop wrote that investors can position themselves to profit from opportunities and protect from risks.

“While the last few years have been highlighted with record swings in market returns and widely oscillating economic data, we expect 2012 will be less about the fringes and more about the middle,” Kleintop wrote. “While moving away from the drastic extremes will be a welcome environment for whipsawed investors, the center offers its own distinct challenges and opportunities. In 2012, finding a middle ground is going to be key for growth in the markets and economy.”

LPL’s predictions for next year look like this:

  • The U.S. economy will grow at a modest rate of about 2%, while emerging markets post stronger growth and Europe experiences a mild recession.
  • The U.S. stock market is likely to post an 8% to 12% gain, boosted by a slight improvement in valuations and mid-to-high single-digit earnings growth.
  • Corporate bonds will post modest single-digit gains as interest rates rise and credit spreads narrow. The yield on the 10-year Treasury is likely to end the year around 3%.

S&P Capital IQ Global Markets Intelligence Managing Director Michael Thompson and V.P. Robert Keiser wrote in their Dec. 5 “Lookout Report” that market players are now less worried about near-term U.S. recession risks than they were in June, when total U.S. employment expanded by only 20,000 new jobs.

“However,” they added, “anxiety over the economy persists as a consequence of bank liquidity contagion risks currently emanating primarily out of Europe.”

The Standard and Poor’s analysts said the 2008 crisis showed that severe economic downturns can be triggered by disruptions to bank liquidity. The difference this time, they noted, is that the European debt crisis is centered around a currency-unified financial system under the direction of the fiscally conservative European Central Bank.

But the end result will be the same if banks inhibit liquidity from flowing to the private sector, according to Thompson and Keiser.

“The challenge currently facing global policymakers is how to chart a course for moderate but sustained economic growth in an environment where regulators are demanding—and consumer behavior is adjusting to—a ‘new normal’ environment, broadly characterized by public- and private-sector deleveraging. The world to us appears to be quickly evolving from the prior loose fiscal and tight monetary regime to a tight fiscal but loose monetary policy supported global economy,” they wrote.

S&P Capital IQ Chief Equity Strategist Sam Stovall

Meanwhile, S&P Capital IQ Chief Equity Strategist Sam Stovall  (left) on Dec. 9 suggested that the S&P 500 may rebound to the mid-to-upper teens in 2012. In fact, S&P Capital IQ’s Investment Policy Committee forecasts that the S&P will end 2012 at 1,400, or a 13.5% advance over the Dec. 8 close of 1,234.

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