If 2011 was dismal for investors and the global economy, expect more of the same in 2012. Gold, yield stocks and commodities might prove a silver lining, however, says one global strategist.
“We’re in the midst of a long-term deleveraging cycle in developed markets. Deleveraging cycles are protracted, they’re painful and typically, they have not been particularly friendly to either economic growth or equity markets,” says Stephen Harris, Head of Research at Macquarie Capital Markets. He was speaking at the Empire Club’s 18th annual investment outlook in Toronto yesterday.
That’s one of five themes he highlights for the next year. Consumers are beset with falling house prices, which increases their leverage ratio, despite their efforts to pay down debt while financial institutions need to do more work to clean up their balance sheets. Then there’s government debt, which he doesn’t think has yet peaked. All the same, “Every dollar used to reduce leverage is dollar that is not used for consumption,” Harris notes, and predicts the U.S. economy will grow at a sub-par 2% for the next several years.
“The worst thing we can do as investors is to look for that V-shaped recovery; it’s going to be more of the same as it has been in the last several years.”
Apart from that, there are sovereign risks – in Europe thanks to the debt crisis in the countries on the periphery and in the U.S. thanks to political gridlock. ”Sovereign risk limits the ability of governments to respond to economic weakness by using fiscal stimulus,” he says. Consequently, monetary policy will have to carry the burden – and low interest rates over a prolonged period will boost yield stocks.
Another theme is the growing gap between developed and developing economies. Developing economies – not facing deleveraging or sovereign risks — have a lot more policy room to foster growth, and are expected to account for 70% of future growth, which bolsters the outlook for commodities.
Still, and this is another theme, developing economies have had to contend with inflation; once they master inflationary pressures, that gives them the freedom to cut interest rates more aggressively, leading to a synchronized global easing, what Harris calls “the sweet spot of the cycle, where policy will be seen to be effective.”
Against that backdrop of gloom, corporate profits outside the financial sector in the U.S. are at a 60-year high. Primarily, that’s the consequence of labour’s loss of pricing power, and as a result “for every incremental dollar of revenue corporations generate, a large portion can fall to the bottom line.”
Still, Harris predicts a climate of three steps forward and two steps back, with equity markets rising higher before pulling back modestly late in the year. He also foresees gold at $2500 an ounce, and higher prices for energy and base metals.
Nick Barisheff, president of Bullion Management Group Inc., thinks gold could go as high $10,000 an ounce. He sees a direct relationship between the rising price of gold and growing government debt, which he says debases the value of currency.
Debased currency, he thinks, is inevitable. Governments have four ways to pay down debt. One is to “grow out of it” though higher productivity and exports. Another is strict austerity, which reduces GDP and thus augments debt at least in the short term. A third is to default on debt. Finally, governments can issue more debt.
“Most politicians will select option 4. … Inevitably, they will choose postpone the problem and leave it for someone else to deal with in the future,” he argues, pointing to the repeated failure of U.S. politicians to get its own debt under control, as well as the continuing Euro debacle.
Higher debt levels, he believes, will lead to global currency wars as governments devalue currencies to increase exports. One consequence is that currencies will lose much of their purchasing power. Already, he says, the U.S. dollar and the British pound have seen their purchasing power reduced by 80% over the past decade. Thus, he argues, “gold can rise as high as currencies fall.”
Some global institutions have taken note. Central banks are now net purchasers of gold. Barisheff thinks its only a matter of time before pension plans and insurance companies start holding gold, a situation that would be a “game-changer” as these institutions seek to offset their exposure to financial assets. But he argues for direct holdings of gold, rather than an ETF.
“In case of fire, would you rather have a real fire extinguisher, or a picture of one.”
Much of this is a matter of mood, argues Fred Sturm, executive vice-president at Mackenzie Financial Corporation. He thinks that the next year will bring “more certainty about how we will attack the problems.” That also means, for investors, “a positive bias … to anything that has limited supply growth.”
That could be gold, but it could also be wealth-generating companies.
Given current uncertainties, he advises “first cover off your basics” with “safety assets.” Then proceed up the ladder with fixed income, especially high-quality corporate debt and dividend stocks. Then there’s the wealth-generating companies that withstand recessions: companies like Apple, Master Card or McDonald’s.
People have probably written off equities at exactly the wrong time, he thinks, noting that every five years, the world adds another 350 million to its population. “Every five years you have to feed and clothe and house another North America.”
People have a tendency, he says, to make short-term decisions for long-term needs. But, he adds, at current rates, it would take 350 years for an investment in T-bills to double.