First quarter scorecard
We retain our view that 2012 will be a good year for risk assets and a challenging year for commodities and Asian currencies. We expect developed market risk assets to outperform emerging market assets on persistent China hard-landing fears.
In our December column “A less volatile 2012” we argued that policy uncertainty, especially associated with U.S. monetary policy, had been the source of the unprecedented financial market volatility since the global financial crisis. We expected policy uncertainty to fade in 2012 as investors became accustomed to new-normal economic fundamentals in the advanced economies.
Reduced policy uncertainty would make economic fundamentals more prominent drivers of risk asset performance. The fundamentals, we argued, were good enough for risk assets to reverse some of their underperformance in 2011 and we expected emerging market (EM) equities to outperform EM debt. EM equities returned 13 percent in the first quarter of 2012 vs. only 3 percent for EM bonds.
We also expected EM equity to outperform developed market equity. EM equity significantly underperformed in 2011 due to a combination of an external factor, which was elevated risk aversion from the eurozone debt crisis and an internal factor that many EM central banks were raising interest rates. Reduced policy uncertainty in the advanced economies and monetary easing or the end of tightening in emerging economies would permit EM equity to claw back some of the underperformance. EM equities returned 13 percent in the first quarter of 2012, more than the S&P 500, the Euro Stoxx 50 or the Nikkei 225.
We expected it to be difficult to make money in Asian currencies. ING’s house view was that the U.S. dollar would be rangebound against major currencies. U.S. dollar weakness from 2002 to mid-2008 was associated with steady appreciation of Asian currencies. The Fed’s quantitative easing or QE1 and QE2 policies also caused the U.S. dollar to depreciate, including against Asian currencies. We couldn’t identify a U.S. trend that would drive Asian currencies in 2012.
We argued that commodities were in a secular bull market but that in 2012 the absence of U.S. dollar depreciation would be a cyclical headwind. We expected commodity prices also to be rangebound with solid emerging market economic growth providing support and a stable to strong U.S. dollar providing resistance. The Thomson/Reuters/Jeffries CRB Commodity Index gained 1 percent in the first quarter of 2012, significantly underperforming the S&P 500.
We were lucky that all Group of Three (G3) countries’ central banks eased in early 2012. The European Central Bank (ECB)’s LTROs and the Fed’s and the Bank of Japan (BOJ)’s adoption of explicit inflation targets reduced fears that G3 monetary policy was inimical to growth. Our house view is that the ECB will offer one more LTRO but that neither the Fed nor the BOJ does anything more than reiterate their commitment to keep interest rates low for an extended period.
Our forecast that EM equity would outperform developed market (DM) equity rested on our forecast of increased accommodation from emerging market central banks. While there was some ― central banks in Brazil, Chile, Indonesia, Israel, Philippines and Thailand cut policy rates in early 2012 ― most of the EM outperformance came in January. EM and DM equities moved together in February and EM equity underperformed DM equity in March.
We think the main reason for the underperformance of EM equity in March was China, especially Premier Wen’s downgrade of the real GDP growth forecast to 7.5 percent from 8 percent. The weak January-February activity data, though distorted by Lunar New Year seasonality, reinforced the impression that the 8.4 percent consensus forecast needed to be downgraded. The official rhetoric also remained hawkish with Premier Wen reiterating that restrictions on the property market needed to remain in place until house prices fell to a “reasonable” level.
Persistent China hard-landing worries lead us to change our view that EM risk assets will outperform DM assets.
The economic fundamentals are good enough to sustain risk appetites. The U.S. came out of the global financial crisis a 4 percent trend nominal GDP growth economy, having gone in a 5.5 percent one. But 4 percent is good enough. Nominal GDP in Germany returned to its long-term 2 percent trend line in 2011 after falling below in 2009-10. EM economic fundamentals are solid and in particular we agree with the consensus forecast that China will deliver another year of 8 percent-plus real GDP growth. Ultimately growth is the economic fundamental that matters most this year.