The year 2011 has been a challenging one, with macro events dominating the markets.
Most regions in the world encountered difficult conditions:
- Japan: tsunami and nuclear disaster
- Europe: sovereign debt crisis
- US: political deadlock regarding debt levels
- Middle East: Arab Spring
- Emerging markets: slowing growth and political unrest.
The world’s equity markets reflected these concerns, declining by 8 percent for the year. The US, achieved a modest positive return. Other regions of the world declined substantially. Europe declined by 13 percent. Core countries such as Germany and Switzerland performed relatively well in the European context, but the decline in the fringe countries brought down the European total. Japan also declined, affected by the tsunami, nuclear disaster and the flooding in Thailand, where many Japanese firms have located manufacturing facilities. The emerging markets were characterized by slowing growth and a range of political dysfunction, which depressed performance.
Source: MSCI
Even given the high level of volatility of the market for the full year, the market volatility during the year was even more extreme. At the end of the second quarter and the third quarter, the various macro concerns, especially the sovereign debt crisis in Europe, as well as the attendant banking risks, drove the market significantly lower. The shift to defensive sectors was evident in the later part of the second quarter and very pronounced in the third quarter. In the fourth quarter, the concerns receded, and the market rebounded significantly, especially the cyclical sectors However, the defensive sectors ended the year as the strongest performers.
Performance 2011 by Quarter and Sector
Source: Strategas, January 2012
The market volatility and performance were driven by macro events:
Source: Strategas, January 2012
Excessive leverage was the key issue facing the market, and Europe was especially problematic. The key concerns were that a default in the one of the fringe countries could lead to contagion throughout Europe and that the European banking system could not survive a significant default. The yields on Euro zone government bonds reflected investors concerns.
Source: Strategas, January 2012
Investor’s search for safe havens extended to the world currencies. Given the difficulties of the economies of the major currencies, several of the currencies with less volume were aggressively purchased. The Swiss Franc was one such currency. The strength of the currency put enormous pressures on the Swiss economy, and the central bank intervened. As a result, the currency fell back to more normal levels. The trading pattern of the Swiss Franc is an excellent summary of the volatile trading pattern in all asset classes, which is not captured in the very modest overall movements of the year overall.
Source: Credit Suisse
The high risk perception of the equity market is reflected in the flow of funds, for the last three years, out of equities. The fund flow into fixed income is somewhat surprising, given that much of the macro risk derives from over-leverage at the sovereign level.
Source: Strategas, January 2012
For 2012, the macro risks remain, though much has been and is being done to contain them. The market situation could remain range bound, especially given that growth will be depressed as government and individual de-leverage from excessively high debt levels. However, the equity market has good value compared to history and excellent dividend return compared to fixed income.
Source: Strategas, January 2012
Source: Value Line, 20 January 2012
