A year ago investors held grave fears for the global economy. Europe’s systemic financial problems appeared intractable. The US was growing too slowly to reduce its unemployment rate. China’s economy was losing momentum, exposing its imbalances. And in Australia, monetary conditions appeared too tight for those outside the resources sector. Investors felt scared and sought safe places to hide. Central banks in advanced economies were acutely aware of the disruptive consequences of permitting this fear to persist. Their commitment to support economic activity, protect the financial system and stamp on financial market volatility, even by adopting nonconventional policies, was the catalyst for an upturn in investor sentiment and the rise in share markets. In the latter half of 2012 and continuing through January, rising optimism was expressed by investors’ interest turning from government bonds to greater focus on corporate bonds, property trusts and higher-yielding equities.
the acute macro-economic threats to investment markets should continue to recede
While it would be wrong to suggest that the global economy is in excellent shape, as we enter 2013 there is reason to believe that the seemingly pervasive control that macro-economic news has held over financial markets will begin to recede. Global growth is likely to be firmly positive, though lower than our experience over most of the past decade. Inflation risk is likely to remain subdued, allowing central bank policy rates to remain low. The impact of political leadership on the markets and economies will be of continued importance in the year ahead. A number of important issues around fiscal consolidation and improved regulatory frameworks for the financial system remain to be addressed. While the volatility in markets, as measured by the VIX Index (see over), has been compressed by central banks, some measures of economic policy uncertainty remain at heightened levels1. We face important elections in Europe and will see how a re-elected President in the US and the new leadership in Japan and China address their challenges.
attention should gradually shift back to fundamentals
Prices of government bonds in “safe” countries have risen to unusually high levels, due to the “flight to safety” and reflecting the expectation that monetary authorities will maintain shortterm interest rates at low levels for a considerable period. Whether investors like it or not “safe” assets currently offer them little reward. However, while the “fear” premium reflected in bond prices today might reduce somewhat, government and corporate bond prices are not expected to fall substantially in the shorter-term. Share market gains over the past year were largely driven by improved investor confidence. There is scope for further increases, as investors become more confident that economic conditions have stabilised and begun to improve.