2012 - Where Best to Invest?

For many investors, 2011 was a tough year, with many asset classes falling in value. With the Eurozone crisis rumbling on into  a third year, and economic growth anaemic in most Western economies, one could be forgiven for writing 2012 off as another year to forget. I do believe that there are, however, subtle differences that could lead to this year being more fruitful for the nimble investor. This is my take on where the major asset classes will be heading during this year - remember this is my opinion only and you should do you own research or seek the advice of a suitably qualified professional before taking any investment decision

Equities (Company Shares)

2011 saw the FTSE100 fall by 5% over the course of the year. As ever, the headline return only tells part of the story, and companies with strong cash flow and earnings, together with a defensive slant, performed best, which is a trend we see continuing this year. Expect Pharmaceuticals and Utilities to outperform, together with a resurgence in Mining and Energy companies, which largely disconnected from increases in the price of underlying commodities during the Autumn of last year. Sectors to avoid are retail and consumer discretionary, which may well endure a difficult year ahead. US Equities appear to offer modest value, and with the US economy seemingly regaining some poise, expect the US to lead the way during the year. Japanese Equities are a interesting proposition, with the massive re-structuring taking place following the earthquake and tsunami in March.

UK Gilts

Gilts were one of the success stories of 2011. Austerity measures implemented by the coalition government, whilst not universally applauded, appear to cement the UK’s position as a safe haven. As a result, 10 year Gilt yields have now fallen to just over 2%. It is unlikely that Gilt yields can fall much further from here and whilst we do not expect a jump in yields any time soon, the bull run for Gilts may be nearing an end.

Corporate Bonds

The Corporate Bond market endured a difficult second half of 2011, as even investment grade issues were caught in the backwash of the late Summer meltdown. Despite this period of weakness, the prospects for investment grade Corporate Bonds remain good for 2012. Underlying interest rates remain low, inflation is likely to fall back slightly over the course of the year and default rates are not showing any sign of a marked increase. Whilst the yields on Bonds issued by financials remain most tempting, we believe exposure to financial Bonds should continue to be limited, given the ongoing concerns over credit quality and the prospects of a disorderly break-up of the Eurozone.

High Yield Corporate Bonds

Higher yielding issues were volatile during 2011; however, a combination of historically low default rates and attractive yields suggests that this may be an asset class that outperforms during 2012. As ever, any extended period of weakness in Equities markets will dampen the performance.

Commodities (Gold / Oil)

During 2011, Gold prices surged to record highs as investors flocked to the precious metal as a hedge against both inflation and the potential for further fallout from the Eurozone crisis. Gold prices have fallen by around 13% from their 2011 peak, and we consider this to be overdone, given the fact that a cure for the Eurozone crisis is yet to be found. Oil prices drifted gently higher during 2011 and moderately higher demand should support prices around current levels in 2012. Any significant unrest in the Middle East, notably in Iran, could see a sharp spike in prices.

Property

Residential property prices generally fell during 2011 and with mortgage lending still restrained, I do not expect this trend to reverse during 2012. Low interest rates should lend some support to the market; however, with increasing unemployment and affordability still an issue, expect another difficult year for the UK housing market. Commercial Property is a little more attractive, but remains vulnerable to further economic downturn.

IMPORTANT - PLEASE NOTE THAT AS EVER YOU SHOULD SEEK INDEPENDENT INVESTMENT ADVICE , TAILORED TO YOUR CIRCUMSTANCES, BEFORE TAKING ANY INVESTMENT DECISION

Where next for the UK Economy

It has now been eighteen months since the coalition austerity measures were introduced, and since then the UK has experienced only one quarter of negative growth, which in itself is not enough to meet the technical definition of a recession (two successive quarters of negative growth). That said, growth in the other quarters has been barely visible, with the latest print for the 3^rd Quarter of 2011 coming in at 0.5%. Some analysts predict that the 4^th Quarter of 2011 saw the UK return to negative growth and we will know next month whether this was the case. I suspect that it will be a close call, but we may do enough to just continue in positive territory. In reality, the semantics of whether we avoid a technical recession or not is largely irrelevant, as for many people it certainly feels like we remain in recessionary conditions. And it is easy to see why.

UK Unemployment continues to climb, reaching 2.64m in December, a level not seen since 1994. With job security a key factor for many, it is hardly surprising that this has had a knock on effect on consumer spending, and the willingness of people to borrow to fund major purchases. Christmas 2011 was described as being a “critical” moment for many UK retailers and the consensus is that general spending was fairly lacklustre. With La Senza, Past Times and Blacks Leisure confirmed casualties over the festive period, and Peacocks/Bon Marche, Game and others on the ropes, it will take a major change in fortune if these chains are to survive the year unscathed. Even supermarket giant Tesco suffered a marked slowdown in sales and warned that profits would come in at the lower end of estimates.

The housing market was generally flat throughout 2011, and (according to Nationwide data) house prices in the UK were over 10% lower than at the peak in mid 2007. Despite historic low interest rates, which should bolster the housing market, the mortgage famine continues. Lenders continue to demand bigger deposits, with figures from the Council of Mortgage Lenders (CML) suggesting that the majority of borrowers now put down deposits of 20% or more.

Amidst all the apparent gloom, one has to wonder what Politicians and policymakers can do to improve the UK’s fortunes? In short, very little, as the necessary austerity drive has given them little room for manoeuvre, either fiscally or through monetary policy. The Bank of England has kept Base Interest Rates at 0.5% since March 2009, and has increased the Quantitative Easing programme to £275bn. It is highly unlikely that the Bank of England will increase rates any time soon, particularly given the fact that Inflation is beginning to ease. Annual CPI inflation fell to 4.2% in December, and with the recent cuts in energy prices announced over the past two weeks, and the effect of the VAT increase being removed from the annual calculations, I expect CPI inflation to moderate to around 3% by the end of the year.

Tax cuts, whilst generally positive from a popularity angle, do not fit with the general austerity message, and the March Budget will undoubtedly be one that aims to reinforce the austerity measures put in place in 2010.   In short, patience will be needed, and it may be at least another twelve months before we see the UK economy on a firmer footing.

There are however reasons to be cheerful, particularly if one looks at the fortunes of some of our European neighbours. We are now one of just 14 countries Worldwide to retain the AAA rating from S&P, and this has kept our borrowing costs relatively low, despite our high debt to GDP ratio. Whether we retain the AAA rating in the long term depends on whether the austerity measures begin to deliver the benefits of debt reduction, without damaging the prospects for economic growth.

Economic forecasting is a notoriously difficult job, but we suggest that, on balance, the UK will avoid slipping back into recession during 2012. Growth will probably remain slow (in the region of 1.5% to 2.5%) and we expect unemployment to continue to be elevated throughout the year. We further expect inflation to moderate, and also expect no action from the Bank of England on Interest Rates. As with 2011, much depends on whether real progress can be made in tackling the issues facing the Eurozone crisis – this is in the hands of the politicians, something that markets aren’t overly comfortable with.