(Foto: lassedesignen – Fotolia.com).
Zurich – As the world economy remains weak, a global recession or recessions in one or more major economic areas is certainly high on the agenda. The much talked about fiscal cliff could by itself shave off 5% of US GDP growth in 2013 and would almost inevitably lead to a US recession. Also, the stronger countries in Europe could be subject to a more stringent and longer-lasting decline than many observers expect at present.
We would especially also highlight the vulnerability of France, Spain, and Italy to potential political hiccups, or more severe budget or funding constraints, which could easily push the already anemic growth path into negative territory. Also China, after a soft patch in 2012, is not back on a full-speed growth path. Every growth rate below 5% would already disappoint massively and reduce global growth prospects substantially.
Sovereign debt
In many (major) countries sovereign debt exceeds sustainable levels and screams for austerity measures, while at the same time stagnation or even outright recessions prevent governments from tackling the problem head-on. There is much focus on the European debt situation, while we think that the US is not much better off. Especially on the sub-sovereign level, many US municipalities face very difficult funding situations.
Stronger austerity measures impair growth, with negative consequences for financial markets. Rising sovereign bond yields burden the public budget with higher interest payments and usually push funding costs for private companies and households up. Furthermore, bond defaults – or in more modern terms “debt restructurings” – leave bond-holders with significant losses. Major investors in sovereign debt are usually banks, insurers and pension funds.
Bank insolvencies
Especially after 2008 we are very aware of the massive adverse impact the failure of a major bank can have on the overall economy. Regulators and governments have been watching banks much more closely since then, and many banks have deleveraged and recapitalized their balance sheets. Still, a partial default of a sovereign or a further real estate crisis could wipe out banks’ equity very rapidly.
Eurozone break-up
We continue to view a Eurozone break-up as an unlikely event, and the sovereign spread tightening in recent months seems to support this view. If at all, we see a certain probability that especially in those member states suffering from deep recessions and austerity measures, opposition against the Eurozone membership could grow strong. This may lead to an anti-EU majority pushing for an exit from the Eurozone.
Outlook 2013
It seems that there is a very broad consensus for a moderate economic recovery in 2013, which will not be strong enough to improve things fundamentally. Still monetary stimulus will be strong enough to offset investors’ concerns about the economy and politicians’ inability to come up with a clear and credible strategy to solve the debt problem. Overall we agree with the macro picture described. As far as financial markets are concerned, we expect equity markets to deliver positive returns in 2013 and, based on relative valuations, we would favor European equity.
Short-term, however, we expect a constructive compromise in the US fiscal cliff negotiations followed by a relief rally. Based on the macro environment, cautious investment and balance-sheet management by most companies, we still like credit. However, since upside for high-grade credit is rather limited, we prefer high-yield and emerging-markets credit, since absolute spread levels still provide enough cushion and carry to compensate for the risks taken. While bond yields may edge higher in 2013, we do not foresee a massive sell-off, since slow growth and wide output gaps are likely to keep inflation of the price of goods low.
As far as currencies are concerned we think that aggressive monetary easing by the Fed and BoJ will leave USD and JPY as the laggards in 2013. As far as the CHF is concerned we do not believe that there is a major upside for EUR/CHF, since the Eurozone problems are far from being solved and investors could easily get concerned about the situation in Portugal, Spain, Italy or even France. Still, we believe that the SNB has the will and the means to fight its lower EUR/CHF currency limit of 1.20 and, therefore, see no benefit for a Euro investor to hold Swiss francs. (BH/mc/hfu)
