In many respects, 2012 was a year of waiting: waiting for a path forward on the European debt crisis; waiting for the results of a polarizing U.S. election; waiting for the Chinese leadership transition; waiting for a resolution to the U.S. fiscal cliff issues; waiting for the Middle East to find peace; waiting for a clear path to global growth; and therefore, waiting to invest additional assets in the markets (or not, as the case may be). In this 2013 Outlook, Michael Cembalest, JPMorgan Asset Management’s Chairman of Market and Investment Strategy, provides a comprehensive summary of the global factors at play, with a tone of optimism grounded in realism. Perhaps just what we need after the surreality of the last two days.
The Odyssey. As we head into 2013, the global economy is treading water…
…with better news in the US and China than in Europe, and with leading indicators pointing to more activity in services than in manufacturing.
The cover art is meant to convey the conflict between the world’s well-advertised challenges (the Squid), and its offsetting strengths (the Ship). The ship persevered in 2012, as the usual suspects that make up most portfolios (equities, credit and real estate) generated doubledigit returns despite low economic growth. The bar for 2013 is a bit higher since equity and credit valuations have risen. However, equity valuations are by no means stretched, and still demonstrate skepticism about the future. While 2013 may be volatile for political reasons…
Looking ahead to the spring, debt ceiling and continuing budget resolutions may be even more contentious. What will the sticking points be? There’s not much left to fight about on non-defense discretionary spending, scheduled to hit a 50-year low in 2017. As shown below, outlays on things like energy R&D, education, worker retraining and infrastructure are increasingly crowded out by entitlements.
The positions are clear: Democrats either simply do not believe that entitlement math is unsustainable, or search in vain for sufficient tax hikes to pay for them; while Republicans search for the political cover to scale back social programs and still get elected. Of all the advice given by the country’s founders, perhaps none is more forgotten than the admonitions in George Washington’s farewell address: to cherish public credit, preserve it by using it as little as possible, and to “not ungenerously throw upon posterity the burden which we ourselves ought to bear”.
…a portfolio of risky assets should generate modestly positive returns by the time the year is over. In all, 2013 looks to be another year of markets outperforming what economic growth conditions alone would imply.
It’s not an overstatement to say that we are living through the largest policy experiments of the last 300 years.
In the US, Europe, Japan and the UK, governments account for 75% of all borrowing that is taking place, and central banks account for 60% of all lending, both multiples higher than anything we have seen (or read about) before. As a sign of the times, monetary policy was the primary issue in the recent election in Japan; voters gave a decisive victory to the party that campaigned on forcing its central bank to provide more of it. Central banks appear determined to reflate financial assets, hoping for whatever spillover they can get to economic growth.
On the following pages, Michael walks through a graphical depiction of the issues on the front cover; an economic review of the US, Europe and the emerging economies; and a summary of investment and market views. At the end, a look beyond 2013 at two litmus tests for America: entitlements and energy independence.