Economic Outlook and Investment Strategy for Q1 2012 

I – Economic Outlook 

• Europe remains fraught with challenges

The situation in both Greece and Spain continues to highlight the inadequacy of the economic and monetary response to the problems plaguing debt-burdened eurozone countries. In the case of Greece, the debt reduction facilitated by the planned default will rapidly prove insufficient given the country’s inability to generate growth and raise taxes. Does this mean that Greece be forced to leave the eurozone? As for Spain, the drastic remedy it is inflicting upon itself to reduce the budget deficit is killing growth, thereby preventing any improvement in the fiscal situation. The risks posed by Greece and Spain, combined with the upcoming elections in France and the economic outlook in Germany, which is expecting negative growth this quarter as in the previous one, make the European landscape a rocky one indeed. 

• The ECB’s active role has nevertheless temporarily alleviated the systemic risk weighing on the eurozone

The ECB’s deployment of an unlimited three-year long-term refinancing operation (LTRO) for commercial banks was a positive step. What is essentially a different take on quantitative easing has temporarily alleviated systemic risk by enabling the ECB to provide the banking system with the liquidity it needs and a mechanism whereby the ECB would no longer be called upon as lender of last resort for sovereign issuers. It also offers banks the chance to get back on their feet with advantageous carry trades, assuming a lasting solution to the European crisis. This mechanism can help provide safe passage through a quarter laden with maturing sovereign issues and inspire a more constructive sentiment towards European equity markets in the short-term. It is our view that for the eurozone to survive it will require both a more expansionist monetary policy and a growth-focused fiscal policy. The former will help by setting key interest rates very low and displaying an ability to buy up unlimited amounts of the most beleaguered countries’ government bonds in order to slash the cost of refinancing public debt and considerably reduce the euro exchange rate. The latter is needed in order to stimulate investment, which brings with it hope of growth and future job creation. 

• United States: the economic recovery has taken shape in the short term

There is no denying that the United States enjoyed an economic upturn over the fourth quarter, prompting 2012 growth forecasts to be raised to around 2%. Gradual yet consistent improvements in the job market combined with the initial signs of stabilisation in the housing market, even though they are yet to be confirmed, are contributing to this upturn. However, we consider it unlikely that these forecasts will be revised upwards in 2012, for three reasons. Firstly, the decline in the savings rate cannot continue to boost consumer spending: the global economic climate in no way justifies a savings rate of 3.5%, a level only ever seen during the formation of the property bubble, which created a false illusion of wealth. Secondly, industrial production is strong as a result of the catch-up process following the return to normality of the production chain, which had been brought to a halt by the Japanese tsunami. Lastly, for companies, the non-renewal of the depreciation acceleration mechanism could weaken investment from January onwards. Although we may be sceptical of the United States’ ability to maintain this trend in the current climate, we have taken note of its resilience.

• Chinese inflation, now under control, will allow for a gradual easing of its monetary policy

As we had anticipated, Chinese inflation peaked at 6.5% in spring, before dropping back to 4.2% in November. Growth should ease off to 7%-8% in 2012 as monetary tightening and the slowdown in global trade start to make themselves felt. Activity is expected to remain at a high level, thereby affording monetary authorities the luxury of very gradually reversing their restrictive policy in a bid to cut inflation expectations as much as possible. Thus, we should not expect to see China easing its monetary policy any more quickly than at present, unless there is a significant downturn in international trade. Its economic policy, which is ever more clearly focused on increasing domestic demand in China, requires strict anti-inflationary discipline and guarantees a boost to global growth over time. It also bodes well for the yuan, which should continue to strengthen along with other currencies in the region relative to those of developed economies. Such an increase in exchange rates serves as an effective weapon in the fight against inflation, which will ultimately bolster the most virtuous countries’ local debt.