2012 – The year patience, discipline & diversification was rewarded
Throughout 2012, nervous investors did not have to look hard for reasons to avoid the financial markets.
At the end of 2011, you could have locked your money up with certainty in a 12 month deposit for 5%. The term deposit investor was immune from bad headlines – fears of a European Union (EU) break up triggered by a Greek exit, concerns that the Chinese economy was heading for a hard landing or that the US economy was going to fall off the ‘fiscal cliff’.
Now the belief that owning a share of the world’s businesses is once again a sensible idea, despite suggestions from some observers that the “cult of equity” is dead.
ECONOMY & MARKETS
The year opened with lingering concern about the weak US recovery and debt crisis in Europe. Many pundits predicted another lacklustre year for stocks and more volatility. Some predicted a euro zone breakup.
But despite a steady diet of bad news, most markets around the world climbed the “wall of worry” to log strong returns. Major market indices around the globe delivered double-digit total returns.
The market value of global equities increased by an estimated $6.5 trillion in 2012i . Meanwhile the media constantly talked about volatility driving investors away, market-wide volatility actually fell to its lowest level in six years.
The Australian stockmarket provided a total return of 19.7% last year despite constant concern over the slowdown in China and resultant impact on our market. The following graph overlays media headlines with movements in the market during the year:
Sluggish US Recovery
In 2012, investors watched eagerly for signs that the US recovery was gaining steam. The weak economy was the central focus in the presidential election, and debate raged over what combination of policies would lead to higher economic and job growth.
Unemployment did fall over the year, albeit modestly, from around 8.5% to 7.8%. As well, corporate earnings and balance sheets improved, inflation stayed low, while housing, car sales and manufacturing activity strengthened.
While the clear result in the US presidential election provided relief, partisan brinksmanship over the so-called “fiscal cliff” was a theme toward the end of the year. A deal reached on New Year’s Day cancelled tax increases and postponed broad spending cuts that could have pushed the economy back into recession.
But as 2013 began, Republicans and Democrats were preparing for more showdowns over taxes and spending in the coming months.
European Debt Troubles
The European sovereign debt crisis carried over into a third year and reached a flashpoint in mid-2012 when Spain threatened to go the way of Greece.
The turning point was agreement by EU leaders to push towards greater fiscal, banking and political integration. The European Central Bank’s announcement that it was prepared to buy an unlimited amount of government bonds also soothed markets.
Many countries in the euro zone still face significant challenges in implementing the reforms necessary to make their economies more competitive, while reducing their debt and deficit burdens.
Against this backdrop, every European stockmarket still produced positive returns in 2012 – an important reminder that economic growth and stockmarket returns are not linked.
China Emerges from Slowdown
According to International Monetary Fund estimates, the global economy grew by 3.3% in 2012, down from 3.8% in 2011 and 5.1% in 2010.
Until this past year, China had picked up the slack from sluggish growth in the US and Europe. But for seven consecutive quarters from early 2011, China’s growth rate slowed to 7.4%, the weakest since the depth of the global financial crisis in early 2009.
As an export-dependent nation, China was showing signs of succumbing to the slowdown in Europe. Together, the economies of all 17 euro-area countries are nearly equal to that of the US. The crisis also threatened to reduce China’s exports to poorer emerging economies in Africa and Latin America.
However, in the latter months of the year, concerns over slowing growth in emerging markets had begun to ease as economies appeared to be bottoming out. China was supported by faster infrastructure investment and a heating up of the housing market. The factory sector also showed signs of picking up as inventories were rebuilt.
Central Bank Action
Central banks in 2012 injected unprecedented stimulus to the global economy in a bid to restore confidence, support liquidity and lift growth.
Many analysts credit Central Bank actions with boosting investor confidence and in the case of the EU, helping avert a euro breakup. Even so, central bankers cautioned as the year came to an end that they were reaching the limits of what they could do.
All asset classes performed strongly in 2012 as shown in the table below (in AUD):
All major equity markets gained substantially in 2012. In developed economies, the broad MSCI index-ex Australia was up by nearly 15%. Australia did comparatively better, gaining nearly 20%. The average term deposit rate for the year was 5.0%ii.
While Australia performed relatively well, the mood of investors was more defensive. This explains why gains were concentrated in large cap and high dividend-paying names like Telstra and the banks. Indeed, Financials and telcos, along with healthcare stocks, were the best performing sectors over the year. Just five stocks (CSL, Telstra, ANZ, CBA and Westpac) comprised half the market’s gains. The graph below shows the returns of each sector:
With the resource boom showing signs of peaking and with commodity prices in retreat for much of the year, materials stocks—particularly at the small end of the market—were among the worst performers of the year.
In Australia, ‘value’ shares underperformed ‘growth’ shares, however in International developed markets ‘value’ outperformed ‘growth’ over the past year.
Investors often forget that seven of the past 10 calendar years has seen the Australian stockmarket produce strong returns. This is displayed in the following graph:
The Australian dollar ended the year almost where it began at around US$1.03–$1.04 (see graph below), although fell to below $US0.98 in May as the European crisis hit risk appetites and when the RBA resumed cutting interest rates.
Most country market returns were positive, although the dispersion of returns was broad. Among the 45 equity markets tracked by MSCI, only three—Chile, Israel and Morocco —posted negative total returns (gross dividends) in their local currency (refer to table below).
WHEN A GUESS IS AS GOOD AS A FORECAST
There were stories in 2012 that reminded us all of the perils of forecasting.
The most notable error was a whopper by the International Monetary Fund (IMF). The IMF had advised European governments to raise taxes and reduce spending to navigate their way out of their financial predicament. The IMF had modelled that for every $1 they stopped spending, their economic growth would suffer by only $0.50.
However, in early January 2013, the IMF announced that for every dollar not spent by European governments, their economies actually contracted by $1.50iii . As mistaken advice, it’s monstrous. Even more shocking, the IMF conceded that there were few unexpected events to explain the variation in expected outcomes.
The little-acknowledged truth is that most expert forecasts are wrong. Not only wrong, but more wrong than if they had been generated at random.
Two decades ago psychologist Philip Tetlock, of the University of California, Berkeley, began testing the forecasts of 284 famous Americans who made their living pontificating about politics and economics.
He surveyed them, asking every few months whether the variable they covered would (a) stay the same, (b) increase or (c) decrease.
After more than 82,000 testable forecasts later he found that as a group the experts performed worse than if they had just selected (a), (b) then (c) in rotation. They performed worse than a dartboard.
There are exceptions. Weather forecasters are especially good. The New York Times data geek Nate Silver got the presidential election results spot on in every state. These exceptions tell us something. Neither Silver nor our weather forecasters think they are experts (Silver comes from sports rather than politics). They are guided by the data – regardless of who it offends – rather than their own judgment.
This is an example of why we adopt an evidence based approach to investments.
Going into 2012, investors could have been forgiven for wanting to stick to cash and stay away from risk assets altogether, such was the pall of gloom over global economic prospects.
Uncertainties over the US economy, the political cycle, the future of the European single currency experiment, the longevity of China’s boom, the resilience of emerging markets and a host of other issues gave many people cause for caution.
But instead, we saw a reawakening of risk appetites through the year, partly due to unprecedented central bank stimulus but partly also to real signs of economic recovery in the US and, later, China.
As is so often the case, earning the rewards offered by the world’s capital markets may have required a combination of discipline and detachment that eluded many investors.Once again, the happiest investors were not those who responded to the daily headlines, but those who remained patient, sticking to the asset allocations ‘tailored’ for them by advisers who are knowledgeable of their personal situations.
Uncertainty will never go away. It is part of risk. But risk is also the flipside of return. We can ameliorate risk by diversifying and paying attention to costs. And we can harvest the returns of capital markets by exercising patience and a mid to long-term perspective.
Some stories don’t change.
i – As measured by the MSCI All-Country World Index
ii – Source: Reserve Bank of Australia website
iii – ‘When a guess is as good as a forecast’, Peter Martin, SMH, 9 January 2013
Author: Rick Walker
Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.