By Pete Gunning, global chief investment officer, and Mike Dueker, chief economist, Russel Investments
Russell’s forecast for 2013 predicts a modestly positive, albeit volatile investment environment, noting investors are likely to see more signs of a global recovery, powered primarily by a continuation of US and Chinese economic growth. Even so, volatility will likely remain elevated through most of the year, driven by the tug-of-war between deflationary austerity and reflationary monetary policy in the eurozone.
Russell’s investment strategists outline and discuss the following six key themes in the global outlook that they believe will have the greatest impact on markets and asset returns in 2013: US market: Addressing long-term issues at last?; eurozone: finding the right policy mix; global equities: a rising tide may not lift all boats equally; emerging markets: due for outperformance; global currency outlook: more of the same, but risks aplenty; commodities: it’s not just about monetary policy. Russell has forecast since 2009 that the US economy would follow a square-root shaped recovery pattern, and events have played out consistently with these expectations. For 2013, Russell’s base case scenario anticipates a continuation of this reluctant-yet-measurably-positive recovery pattern. The US strikes us as an undervalued field, both in terms of the equity pricing and overly pessimistic economic growth expectations. We would be surprised if the equity market does not cash in that value by the end of the year. The squeeze play: searching for real returns in a yield-starved world On the other side of the square-root shaped recovery, with real interest rates in negative territory, is the reality that investors still have the demand of a real return on their assets. In view of the dynamics of the US recovery, lingering impacts of the Great Recession and intervention by the US Federal Reserve, Russell forecasts the net effect on investors will be that of “squeezing” them out of traditional safe-haven assets and forcing them further up the risk curve. Since only positive real returns build wealth, investors are forced to confront the question of what is to be done in a yield-starved world. This ‘squeeze play’ impulses people into riskier assets; we continue to advise clients to proceed purposefully and with strategic discipline. For investors, this means attention to every detail of their portfolio management. We believe regional diversification will need to be firmly in place, as the economic center of gravity will continue to shift. As traditional investments remain flat, alternatives likely will matter more than ever. And volatility, while it certainly brings market stress, will also bring market opportunity for multi-asset, dynamically- managed portfolios. Core expectations for 2013 The square-root shaped recovery will continue, with US economic growth of 2.1% for 2013, increasing to 2.5%-2.75% by the second half of the year; tepid US core inflation for the medium term at 1.9%. US 10-year Treasury yield at 2.15% by yearend 2013; real-time indicators are not pricing in a fiscal-cliff disaster, but rather a smaller degree of fiscal drag. A cyclical recovery for the Chinese economy delivering GDP growth of around 8% in 2013; and a eurozone which will remain intact, with a continuing tug-of-war between austerity and growth. Based on our central-tendency scenario of 2.1% real GDP growth and modestly rising bond yields, we project the US stock market will end 2013 up in single digits. This assessment takes into account corporate profit growth slowing to match nominal GDP growth and a small drop in the equity risk premium as doomsday scenarios diminish in likelihood.
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