January 2012 seemed like a follow through of the end of year rally as US indices strength extended into the new Year (S&P 500 up 4.3% in January). This has allowed European equities and Emerging markets to play catch up (Dax up 9% and Russia 15%). Like in 2011, commodities are displaying a good correlation with equities. Rates have initially sold off to finish the month broadly unchanged, while European peripheral markets improved absorbing good supply of new bonds..
What can we expect from 2012, now that the financial year has truly started?
Firstly, G3 central banks will likely keep their repo rates at very low level, as the Fed already announced for the US. Low growth and Euro area woes combined with global banking funding weakness will prevent any tightening in the medium term.
Long yields should therefore oscillate in a relatively tight range, with potential additional QE if bond markets start selling off.
In Europe, the resolution of the sovereign debt crisis will be a slow process and is unlikely to come before 2013. If, at last, everybody is aware of the efforts to be made, the budgetary equations will not be easy to solve in a context of low growth or even recession in some countries. Further downgrades are to be expected and beyond, discussions on debt restructuring and collective action clauses will continue to weigh on peripherals. Many traditional buyers of sovereign debt will switch to corporate credit and covered bonds. The overall credit climate should continue to be heavy.
However, with very low rates, relatively low blue chip valuations, and potential exit scenarios from the 2011 crisis under consideration, equity markets could find a good base even if January has already been strong. A true breakthrough, though, will only happen once the banks recapitalization process is truly out of the way and that growth prospects start to be clearer. We are not there yet.
Recent strong correlation between EM and DM should remain valid. Same thing with commodities markets.
Obviously, at SEVEN Capital, our objective is to follow and understand all these potential developments and make sure that our quantitative models capture the risks as they appear, unfold or disappear, to deliver the best returns for the investors in our funds. We strive to continue to improve our allocation strategies, but without making any discretionary calls on what might or might not happen; and to implement a disciplined investment strategy that has worked well during the last 5 years.