Forecasting is a perilous business. Delivering their outlook for 2011 to several pension fund trustees, one group of City economists identified a sharp jump in inflation as the biggest risk facing investors. The second biggest risk was outright deflation.
“The trouble is,” says Gerard Lyons, head of global research at Standard Chartered, “while the economic fundamentals should be clear-cut, there appears to be widespread disagreement on what they are.”
Mr Lyons blames the central role being played by politicians and central bankers in markets for all the uncertainty over what next year holds.
With governments the biggest drivers behind asset prices, and with the US, Europe and countries in Asia all struggling with different challenges, then prediction becomes even trickier.
“It’s possible to construct a host of widely different and credible scenarios for the year ahead,” says Mr Lyons. “Within these, so-called ‘tail risks’, or extreme scenarios, cannot be ruled out.”
These caveats aside, some sort of “base case” scenario is emerging in all the reports spewing out of investment banks’ research teams. The consensus view is that the global recovery will continue, with some inflationary pressure, but not enough to force central banks in the US, Europe and Japan to reverse super-loose monetary policies.
For equities, this is probably good news. Indeed, a bullish scenario has been embraced by Morgan Stanley’s European equity team, who believe that further growth will help the MSCI Europe index rise 11 per cent to 1,250 next year. It will not be a smooth ride though: their report is called “Bumpy, but better than bonds”.
On the other side of the Atlantic, John Lynch, chief equity strategist at Wells Fargo, is predicting that the S&P 500 index will rise to 1,300 by the end of 2011 from about 1,200 at the end of this year – an 8 per cent gain.
“We are slightly overweight large [compared] to small-cap companies and we are also overweight growth to value stocks,” says Mr Lynch. The danger is that sluggish employment leads investors to trim earnings expectations.
Mr Lynch’s optimism pales next to that of Goldman Sachs analysts, who are talking of the S&P 500 rising as high as 1,450, a 19 per cent gain, by the end of next year, powered by low borrowing costs, low inflation and continued earnings growth.
This forecast is one of a series of bullish predictions by the bank’s strategists, who are basing their expectations on another year of above-average growth of 4.6 per cent in global output, as against consensus expectations of 4.1 per cent growth.
In contrast to Goldman, Citigroup analysts are predicting global growth of 3.4 per cent next year. Michael Saunders, economist at the bank, says this is because only half the world economy this year was expanding faster than its long-term average.
“For roughly half the global economy, 2010 was not a particularly good year,” he says. “For 2011, we expect only about 45 per cent of global GDP will be in high-growth economies.”
Interest rates are central to investors’ expectations. Most analysts are predicting no increase by the major central banks on the grounds there is still enough spare capacity in the world’s developed economies to accommodate very loose monetary policy.
This should result in further dollar weakness, not least because of the Fed’s decision to embark on a second round of “quantitative easing”, or heavy buying of Treasuries to stimulate the economy, a programme that will last until at least June.
Moves by some central banks to raise rates could also keep the dollar under pressure. “Several central banks delayed tightening in 2010 due to risks from the US, Europe and China,” says John Normand, global head of foreign-exchange strategy at JPMorgan, who lists regions with house price inflation including some Nordic countries and Switzerland, as potential rate risers.
“Money markets are not priced for this outcome and the resulting spread movements should be dollar-bearish,” he says.
Low US interest rates, and a weak dollar, are likely to support gold, seen by some investors as a hedge against both the short-term risk of a double-dip recession and a longer-term jump in inflation.
Again, Goldman strategists are taking the lead and are expecting a further 20 per cent jump in gold prices. Gold will then peak at about $1,750 in 2012, they say. One of the bank’s commodities strategists, David Greely, says: “It is prudent for gold investors to begin to prepare for gold prices to peak in 2012, and we suggest protecting against downside risk in what we continue to expect will be an upward trending market in 2011.”
The overwhelming consensus may be for growth, but there are plenty of vocal bears. One of the best-known is David Rosenberg, chief economist and strategist of Gluskin Sheff.
He expects only low single-digit nominal growth in the US economy next year – versus a prediction of 2.7 per cent from Goldman and 2.5 per cent from Citigroup.
“After a year of surprising on the upside earnings will begin to surprise on the downside,” he says. As a result, the S&P 500 will slide to the bottom of its recent trading range of 1,000-1,200 and “quite possibly below”.
He likens the rally of 2009 to the post-crash stock market gains of 1930, when equities rose 20 per cent. Therein lies a cautionary tale, he says.
“The reason no one talks about that ever is that the market made its lows in 1932.”
Additional reporting by James Mackintosh in London and Michael Mackenzie and Gregory Meyer in New York
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