Savour International

What does VP Bank expect for 2012?

We expect the new year to get off to a disappointing start. The Eurozone will probably not even live up to the markets’ already low expectations. Improvement will not come until the second half of 2012 – too late to push up inflation to a healthy 2–3% before the end of the year.

The future shape of the Eurozone will emerge in the second half of 2012 at the latest. In Switzerland deflation risks will continue to predominate. We advise you to concentrate initially on corporate bonds in all rating categories. International equity markets will not recover until after the expected full-blooded intervention of the European Central Bank in the debt crisis.

 

But yield differences between individual Eurozone countries will persist even after the crisis of confidence is resolved.

 

Eurozone still in crisis

We expect the Eurozone to post negative growth rates in the first half of 2012. Scepticism about the crisis management skills of European governments is undermining sentiment in the real economy and the financial markets. European banks are consolidating their balance sheets in order to avoid having to rely on injections of government capital. At the same time net capital inflows from abroad are diminishing.

Many Eurozone countries face the challenge of further major adjustments in their labour markets. In many cases real wages will have to fall if the country wants to stay in the Eurozone. Otherwise unemployment will continue to rise until labour productivity reaches an adequate level. The selling pressure on Italian government bonds is creating irresistible pressure for a comprehensive solution, probably involving the participation of the ECB as lender of last resort and perhaps the exit of Greece from the Eurozone.

 

Modest growth in US and Switzerland

The US and Switzerland will again grow faster than the Eurozone in 2012. The US is forecast to grow by around 1.5% and Switzerland by 1.0% (the same as Germany). Nevertheless, real per capita incomes almost everywhere are flatlining or even edging downwards. Switzerland can partly escape negative macro developments in the Eurozone by taking further fiscal and currency measures if necessary. Action of this sort would also shield Switzerland’s current account from even larger inflows of capital.

 

Soft landing in Asia thanks to domestic demand

China is achieving a soft landing, with growth set to stay in high single figures in 2012. The construction sector will face setbacks due to overcapacity. Decelerating inflation paves the way for interest rate cuts throughout Asia. The growth engines of the Asian region include China, India and Indonesia.

Low wage costs and undervalued currencies have enabled Asia to sell its goods and services on world markets very successfully in the past. Rising incomes are now fuelling higher domestic demand for consumer goods. Expected feeble growth in the industrialised world will give additional impetus to this shift towards domestic consumption. You can acquire a stake in these developments by investing in VP Bank’s “Tomorrow’s Consumers” equity basket. The overall picture for the emerging markets in 2012 is mixed. While Latin American economies should continue to grow at about the same rate as in 2011, the export-oriented eco-nomies of Eastern Europe face setbacks caused by dwindling orders from the Eurozone.

 

 

Deflation risks still predominate

Inflation in 2012 will be excessively low, and the danger of deflation will persist. In this environment it is quite feasible for the European Central Bank to take action to head off a possible selling wave on European government bonds. But Europe, above all Germany, is still in mortal dread of inflation, and a sovereign bankruptcy is regarded as the lesser evil. Other factors are also holding inflation down: economic

activity will recover only hesitantly in the second half of the year, leaving much capacity idle. Thus inflation expectations will stay low. Falling home prices in the US and the strong Swiss franc are additional disinflationary factors in these countries.

 

 

Support from the corporate sector

Corporate profits will continue to grow in 2012, even within Europe. No impulse can be expected from the domestic market, but European companies will benefit from their international trading links. Around 43% of European companies’ sales are achieved outside Europe. Strong balance sheets provide companies with a cushion against subdued economic growth. Strict cost discipline will be maintained.

 

VP Bank’s investment recommendations

In our view, new investments in the early months of 2012 should be focussed principally on corporate bonds. In contrast to high-quality government bonds, credit spreads on corporate issues provide a positive (albeit low) real yield. Balance sheet data, notably liquidity levels, suggest that the risk/return profile is appropriate.

Risks in the government bond market remain very high. Interest rate differentials between some European government bonds and German Bunds are excessively wide, but this will not create an attractive buy opportunity until the Eurozone has regained its credibility. When that happens, we expect to see substantial capital losses on Bunds, US Treasuries and Swiss federal bonds. In view of the one-sided interest rate risks we continue to recommend short maturities. Hard currency bonds of many emerging market countries are avoiding the general turbulence on the financial markets. The solid macro situation in these countries makes them an interesting investment alternative to Eurozone bonds.

Despite moderate valuations, equity prices have not kept pace with rising corporate profits in recent years. Economic weakness and continuing uncertainty are leaving their mark. We expect to see a gradual return to cautious optimism on the equity markets in the course of 2012. Equities may then benefit from energetic action by the European Central Bank.