A look at Market Returns for 2010
2010 will not only be remembered for the year that the Tipperary hurlers brought a halt to Kilkenny’s five in a row dream, but also as the year that the Eurozone sovereign crisis unravelled. However neither event was big enough to derail the equity market rally that started in March 2009, although the latter was responsible in creating much volatility for equity, bond and currency markets.
2010 was a year of sharp contrasts for investors, with great rewards for players who managed to be on the right side. Examples include fears of a double dip recession in the developed world versus the strong growth in the emerging economies, concerns about the over indebted governments and consumers compared to the cash rich corporations, record low bond yields in triple A countries versus high yields in the peripheral Eurozone countries such as Greece and Ireland. Finally the fiscal austerity measures being adopted across Europe compared to the unprecedented government and central bank stimulus put in place in the US.
A re-rating of the risk free asset class
The sovereign debt crisis which first emerged in January 2010 when it became evident that the fiscal situation in Greece was unsustainable. This crisis led to a reconsideration of safe assets as the risk of default is now being priced into what traditionally have been the one of the safest asset classes’ government bonds. Going into 2011 it is likely that the re-rating of safety is likely to continue as the rating agencies have signalled Greece, Portugal and possibly Spain are faced with further downgrades, while there are also rumblings that the “ultimate safe haven”- US Government Bonds could be put on review for a potential downgrade. Hence as the risk of default was priced into bond markets the appetite for the bonds of riskier countries declined. The danger is that as the number of “risky” countries increases that bailouts are less feasible. On the other hand, the credit risk attached to companies is easing, particularly as the balance sheets are very healthy but also as companies are much more mobile and have the ability to get exposure to countries with robust growth. As a result the spread between government bonds and corporate bonds has declined through 2010 and corporate bonds outperformed conventional government bonds.
Benign and uneven economic recovery
Expectations for the recovery in the US also deteriorated during the year, particularly as leading indicators peaked and have eased since the start of the year. Elsewhere, the recovery to date in the US has been jobless as the unemployment rate remained close to its peak at 9.8%. The negative economic data, during the year weighed on markets. However, in November and December policy makers in the US have stepped up as the Federal Reserve announced it will buy as much as $600bln government bonds and the US government announced an extension of the tax cuts and additional stimulus to business. This additional stimulus has boosted the outlook of the US economy for 2011 going into the year end; however concerns are also mounting about the sustainability of US government’s deficit.
The returns for equity markets have been supported by earnings growth
Earnings expectations for 2010 in both Europe and the US are set to come in well ahead of expectations. In January 2010 analyst were expecting that earnings for the S&P 500 would grow by 26% however at the end of December expectations had increased to 42% growth, while in Europe expectations have increased from 25% growth to 35%. The improvement has been driven by increased cost cutting, particularly in the US as well as double digit earnings growth from companies that have exposure to emerging markets. These measures have offset the sluggish low single digit revenue growth that has been experienced from developed countries.
Emerging Markets outperformed Developed Markets
Both emerging market debt and equities saw strong money flow as the outlook for the emerging economies continued to improve and investors sought to get exposure to companies, government bonds and the currencies of these regions. The emerging economies have continued to expand beyond the emerging Asian region as Latin America and Europe, Middle East and Africa (EMEA) region are also seen as attractive. The continued expansion of the middle classes in these regions is expected to drive growth in these countries over the next few years. The latest concerns for these regions are that they will over heat, particularly as food inflation, which has a much higher impact on consumer price basket in emerging regions than it would be in the developed economies, has been rising.
What about 2011?
Going into 2011 it is hard to believe that the sovereign concerns that started in 2010 are going away, if anything it is likely that these concerns will intensify early in the new year as countries attempt to front load the new debt issuance during the first quarter. This also with the treat of further downgrades by the rating agencies will lead to continued volatility for both bond and equity markets. Despite this, continued strong earnings, supportive valuations and robust corporate balance sheets are likely to support equity markets during 2011.
Important – Disclaimer
This document is intended as a general review of investment market conditions. It does not constitute investment advice and has not been prepared based on the financial needs or objectives of any particular person, and does not take account of the specific needs or circumstances of any person. Any comments on specific stocks are intended as an objective, independent view in relation to that stock generally, and not in relation to its suitability to any specific person.
ILIM and ILA manage investment funds which may have holdings in stocks commented on in the document. These products may be affected by changes in currency exchange rates. Past performance may not be a reliable guide to future performance. Investments may fall as well as rise. ILIM and ILA are regulated by the Central Bank of Ireland.