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Article10 Jan 2012

2012 Investment Themes

Navigating Towards a Growth Course
Most investors were only too happy to see the back of 2011 and now look forward to 2012 with a sense of cautious optimism that things will be brighter. What do we think brighter means? For our purposes, it means growth - growth in confidence, growth in employment, growth in income, growth in spending and growth in the economy. 2012 looks to be a year where we seek to get ourselves out of the doldrums and get our confidence back. Inevitably, though, we will encounter challenges on the path to growth - some that are forecast, some that will surprise - in addition to a certain amount of "baggage" that we carried forward from last year despite us wishing it would disappear with the turn of the calendar page.

Globally we expect the economy to grow 2.5% in 2012, down from about 3% in 2011 and from over 4% in 2010. Compared to a typical recession, today's GDP growth is somewhat weaker than expected and unemployment is still much higher than one would expect to see at this point in the recovery. Because of this, many investors are beginning to believe that the major developed economies are on the threshold of a "lost decade". Governments, households and financial institutions are working to pay down debt levels that have been building up over the past 30 years - built to levels that haven't been seen since the 1930s. History shows previous periods of de-leveraging have often been times of below-average real GDP growth and "lost decades". The question that needs to be answered is whether the world can delever without this having a knock-on effect on asset prices and economic growth. We think confidence could be the determining factor here.

The crisis in Europe continues to be a drag on the global economy, with the sovereign and banking crisis likely to lead to a protracted recession in the eurozone. Incremental fiscal tightening, structural reforms, tight financial conditions and a continued "uncertainty overhang", which is weighing strongly on domestic demand, all contribute to the curtailing of economic growth. The European crisis is not just a European problem as multi-nationals that trade directly in Europe and firms that compete with European exporters in other markets are all affected. Although the euro area will be under intense strain, we believe it will likely remain intact and, given the high costs of exit for any member country, a break-up of the eurozone has less than a 5% probability.

Despite the obvious macro headwinds, global corporate earnings and cash flow continue to grow at a solid rate. While these are typically a positive sign for investment and job growth, high levels of volatility and ongoing uncertainty of late have resulted in a meaningful slowing of capex investment by corporates over the past two years. With the cost of equity high and the cost of debt unusually low, corporates have instead been deequitising - using cash to buy cheap equity or pay big dividends. Although this should continue to support stock prices going forward, it remains to be seen if economic growth can recover without an increase in capex to fuel job growth.

Discussion around tail risks will continue to make headlines in 2012 as investors and corporates worry about the potential of the "next shoe to drop". The fate of the Chinese economy and whether its growth engine can continue to drive global demand is a concern but we believe rebalancing to promote structural and marginal demand would lay a solid footing for continued growth. Countries moving towards financial repression to solve their debt problems could also slow emerging market growth but we argue that EMs might react quite favorably to such measures. Commodities are being torn between lower demand impact from the U.S., Europe and China and supply disruptions due to political unrest. For 2012, we believe most commodity prices will be range-bound but subject to both downside demand and upside supply tail risks.

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Economic Outlook

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