2012 was a year of confusion, risks anticipated and risks averted. Globally, investors feared a European Union break-up, a Chinese economic hard-landing and a Middle East conflict. Domestically, investors worried about the coming election and the fiscal cliff. Few investors expected what 2012 actually brought.
- Greece, Portugal and Ireland had the best performing bond markets
- Financials was the best-performing equity sector
- Technology and Treasuries were the worst-performing sectors
- Housing recovery
- Energy independence,
- The year of the consumer
- A year for the few (relative to bond investors) brave equity investors.
- Economic growth remained weak, but
- The lack of crises — coupled with unprecedented monetary stimulus — was enough to generate good returns in most asset classes
- Many asset classes experienced double-digit gains.
- As an asset class, Emerging Markets rose almost 19% in 2012, beating both the 16% rise in US markets and the near 17% return in the Developed International markets.
- In contrast, hedge funds gained an estimated average 5.5%, finishing 2012 well behind the stock market’s double digit gains.
Sources: Morningstar Direct and Hedge Fund Research, Inc.
2013: The Year Ahead
Investors looking ahead to 2013 face two uncertainties:
- Will stocks get knocked off their 2012 run due to the US’s unsettled fiscal outlook, with expected slowdown in US Corporate earnings, and/or uncertainty around the world like in Europe, Middle East, China and Japan?
- Will the insatiable search for higher yield lead enough investors back to stocks after several years of embracing bond’s perceived safety and accepting their flat returns, thus continuing to fuel the equity markets?
In our opinion, 2013 could be another volatile, attractive year, as so many have been of late. Data suggests the equity markets look relatively cheap from a valuation perspective, and certainly much better than the limited potential we see in the fixed-income market. For now, we remain cautiously optimistic, but we are cognizant that there is still much hard work that needs to be done to restructure the global economy and uncertainty over whether we have the political will.
Asset Class Implications
GV’s Investment Team provides insights in the 3 major investment arenas below. This is based on an in-depth analysis of the economic headwinds and tailwinds, to identify opportunities and dangers in 2013 and asset classes which might be overvalued or undervalued. We focus on managing risks in a portfolio rather than chasing returns.
- We continue to conclude that the historic 30-year bull market in bonds is in its last stages and that bonds are not an investment for ages. With that in mind, we continue to review our bond allocations closely, diversifying into various bonds sectors and increasing allocations to Global Bonds.
- Municipal bonds maintained their federal tax-exempt status in the recent budget deal, giving munis at least a short-term reprieve; we think caution is warranted due to high valuations and high demand.
- With a low default rate, data suggests that High Yield Bonds appear to be fairly valued yet not as attractive as they were in 2012. We maintain an allocation to these bonds for their higher coupons.
- We continue to see data that equities are relatively cheap from a long term valuation perspective.
- Domestic and International stocks continue to offer value, although our valuations analysis reveals that International stocks (particularly European stocks) continue to be historically cheap relative to U.S. stocks.
- We believe that Emerging Markets economic growth will accelerate in 2013, giving companies an opportunity to boost profits, and thus we maintain a bias towards these markets.
- Large-Cap companies continue to be cheaper to Small-Cap companies but by not as much as the last year. As such, while we maintain a slight preference for the relative cheapness of Large-Cap companies, we have reduced our bias towards Large-Cap stocks.
- While Growth stocks as an asset class remain cheap relative to Value stocks based on valuations, the discount (cheapness) has declined from prior levels. Source: Leuthold. Growth equities might offer opportunity due to greater global exposure; however, they appear to be less attractive than last year.
- We maintain an allocation to Commodities as we think that the demand for scarce resources, a possible inflation hedge and their oversold status warrants maintaining this asset classes as a diversifier in portfolios.
- We maintain an allocation to Real Estate stocks through REITs as fundamentals appear to be improving across all property sectors.
- We maintain an allocation to some Alternative funds that seek to maintain a negative correlation to the equity markets.
The short-term performance of the market is never predictable. A recent case in point, despite investor fear of the imminent fiscal cliff, the market kept rallying in December 2012. Trillions of dollars of capital have flown into short-term investment strategies which we believe has created one of today’s greatest market inefficiencies. With so little capital devoted to long-term investing and so many investors focused exclusively on the near-term macro visibility, there might be advantages for investors in today’s valuations and bearish sentiment; we could very well be witnessing the groundwork for the next secular bull market in equities.
We wish you and yours a happy and prosperous new year.