The year 2011 may not have been an annus horribilis, but it has certainly has had a full share of economic, political and environmental challenges. Economic problems have included the ongoing euro area sovereign debt crisis, weak growth in the US, as well as a slowdown in China. Political stalemate has characterized US politics, while unrest has been a feature in many regions of the world, including various anti-austerity demonstrations in Europe, the Occupy Wall Street movements, and the Arab Spring in the Middle East. Finally, the environmental catastrophes have included the Japanese earthquake, tsunami and Fukushima nuclear leaks as well as the massive flooding in Thailand.
Despite these problems, The MSCI World Index is down just 7.5 percent year to date. However, this relatively benign total figure masks the extreme volatility that has characterised the year, especially the sharp decline during the summer.
The greatest immediate risk to the world economy lies in the euro area, due to the uncertainties of the sovereign debt crisis and the potential negative consequences for the European financial sector. The potential remains for further negative as well as positive outcomes. A positive resolution requires determination of credible policy position and adequate resources to fund the solution. Contagion, as reflected in the elevated sovereign debt rates, has spread from Greece to Italy, Spain and Belgium. One positive note, rarely reported in the press, has been Ireland. The Irish have managed to pursue an economic austerity policy, and seen its sovereign debt rates decline. The risk of a second financial melt-down, similar to the financial crisis resulting from the mortgage backed securities collapse in 2008 and 2009, is the nightmare scenario haunting the European sovereign debt crisis.
The OECD economic outlook forecasts the economic perspective for the next two years. Several interesting trends are evident, which suggest some investment opportunities:
- Economic growth for the OECD in 2011 has been anemic. Overall economic growth in 2012 is expected to remain muted as de-leveraging at the government and individual levels in much of the developed world will put a damper on growth. Growth in 2012 should continue its current rate, with weakness in the euro area offset by a recovery in Japan.
- Japan has had a particularly difficult 2011, with growth adversely affected early in the year by the earthquake, tsunami and nuclear accident. The flooding in Thailand has also disrupted an important portion of Japanese companies’ off-shore manufacturing base. As disruptions to the manufacturing sector’s supply chains are restored, growth is expected to resume. The Japanese market has been an underperformer year-to-date, with a loss of 15%, twice the global loss of 7%. An investment opportunity is developing for some Japanese firms, which have attractive valuations and being positioned for a recovery in earnings growth.
- Most economic growth will continue to emanate from emerging markets. These markets, including the ‘BRIC’ (Brazil, Russia, India and China) countires are faster growing than the mature markets. In addition, these markets are growing in size and now constitute a majority of the global growth. This year, the pace of growth in some of the largest emerging markets has declined. This slowdown, combined with relatively high valuations, has led to a year-to-date decline in the MSCI emerging market index of -17.5%. Some investment opportunities may be developiong. Many developed world corporations, which have been reporting strong earnings growth despite the slowdown in the developed world, have positioned themselves to participate in the emerging market growth.
