Most asset classes bar major government bonds have seen a pullback in recent weeks amid renewed concerns over the European economic and financial crisis, a slowdown in China and the weak secular economic growth in the advanced economies. The MSCI AC World Index (including both advanced and emerging equities) has corrected by some 12.7% from its year-to-date high in local currency terms, while ten-year treasuries, gilts and bunds have fallen to 1.72%, 1.83% and 1.43% respectively (as at 18 May 2012).
Europe at the epicentre of global risks
The focus is on the risk of a Greek default and eurozone exit and the lack of growth in the region. The political uncertainty in Greece is increasing the risk of a run on its banks and raising fears of contagion to other parts of Europe. Germany may eventually have to provide the backstop to the peripheral economies' debt problems. The other element of this crisis is the lack of growth in the region.
The peripheral economies are in severe recessions and the core economies, bar Germany, are seeing a sharp slowdown. While they are very much inter-related, Europe's problems are not just about austerity – they include deleveraging, uncompetitive economies, the relative strength of the euro (despite having fallen by 10% over the past year) and political uncertainties. Thus, the region's prospects over the medium term will largely be dictated by both politics and the need to implement supply side reforms.
US and emerging markets growth is key
The hope is that signs of a stabilisation in the US economic recovery and comparatively decent growth in the emerging economies hold to offset weaknesses in Europe. There are tentative signs of an improvement in US housing activity, job creation remains positive though slowing and retail sales continue to hold up.
Meanwhile, growth in the emerging economies is expected to be 5.7% in 2012 and 6% in 2013, according to the latest IMF forecasts. As a result, global growth is expected to be 3.5% this year and 4.1% next year.
Navigating in an uncertain environment
A stabilisation in the US economic recovery and decent growth in the emerging economies should provide support to corporate earnings, while equities appear inexpensively valued on most measures. However, structural risks abound, with high government debts and uncompetitive economies in certain parts of Europe, China's transition to a more domestically-orientated economy and the US 'fiscal cliff' (though the stock market has not been too concerned about this latter issue thus far). The key to navigating the uncertain environment is a focus on companies with robust business models and global franchises as well as having a well-crafted, diversified portfolio.
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