Partner Article

New year, same message: stay diversified

Barring something unexpected, it’s unlikely returns on risk assets will either be devastatingly bad or spectacularly good over the course of 2012. Lingering fears of a repeat of the global financial crisis of 2008-09 will probably keep day-to-day market volatility at unusually high levels for at least the next few months.

With high but directionless volatility likely to persist, investors can’t be blamed for asking ‘why put up with the anxiety of bad market runs for what’s likely to be modest returns?’ With the current levels of short-term interest rates and inflation, avoiding day-to-day volatility by investing only in ‘risk-free’ assets means losing upwards of 2% of your money’s annual purchasing power. A diversified, multi-asset class portfolio offers a decent chance of preserving, or even slowly increasing your purchasing power.

While double-digit returns in either direction are unlikely over 2012, it will make a great deal of difference whether the actual single-digit outcome is positive or negative. Which way it turns out depends on the actions of two key groups of global decision makers: US consumers and European politicians.

Our basic thesis is that the gradual global economic recovery will continue: global business revenues will grow modestly, unemployment will decline slowly, and labour costs will remain under control – a recipe for continued solid earnings growth. High unemployment will keep interest rates low, which should (all else being equal) support equity market multiples. Current equity price levels reflect a more pessimistic outlook than ours, so the base scenario for 2012 is global stock markets perform reasonably but not spectacularly well.

The biggest risks to this benign case are a drop in US consumer spending and European policymakers unintentionally steering their economy into a severe recession. US consumers, who account for 14% of total global purchases, face a few major challenges: slow income growth in a weak labour market, lower prices for their most valuable assets (homes), fewer years left to save for retirement, and possibly higher taxes and lower benefit payments. If they respond to this outlook by cutting back on spending, the US could easily tilt back into recession. And in the euro area, excessive fiscal austerity in the south could combine with sapped consumer confidence in a crisis-weary north to turn a mild regional downturn into something substantially worse. European economic performance in 2012 depends much more than usual on how well policy makers do their job: whether they muddle through their debt crisis badly or well.

We opened with the phrase “Barring something unexpected” with the dramatic events of 2011 in mind. The Arab Spring and Tohoku earthquake are good reminders for investors to expect the unexpected. By definition we don’t know what the unexpected events will be or whether they will be pleasant or unpleasant surprises. The only way to defend your wealth against unpleasant surprises or to benefit from unexpected good news is to build and maintain a well-diversified portfolio with enough liquidity to allow you to respond appropriately. That’s an approach we’ve advocated for many years and probably will do for years to come.

As always, we do emphasise that investing in shares is not for everyone. Their value can fall and you can get back less than you invest – if you are unsure, you should seek independent advice.

By Richard Clark and Simon Patterson, Private Bankers at Barclays Wealth, Newcastle

This was posted in Bdaily's Members' News section by Richard Clark .