2011 was a challenging year, and not just for the stock market. From natural disasters to political battles, markets faced one issue after the next. In this three part series, we will look back at the last twelve months and review some of the biggest factors influencing the economy and their potential impact going forward. In Part Three, Balentine discusses the challenges faced by the developed world and the continued implications as we enter 2012.
The developed world faced many challenges in 2011. Everything from nature to politics had a hand in affecting not only the global economy, but particularly the developed world. While some issues only impacted global markets in the short-term, the effects of some will be felt in 2012 and for years to come.
In March of last year, a massive earthquake and tsunami dealt a serious blow to an already weakened Japan. Plagued by interest rates at near-zero and the highest public debt burden in the developed world, Japan’s recovery will be long and arduous. Nevertheless, history tells us that the impact of the earthquake on the global economy and market over the long-run will be minimal. Despite the short term market volatility and risk aversion, global markets soon returned to normal levels in the ensuing months.
Though it did not suffer any natural disasters, the U.S. did face a political maelstrom for much of the later part of last year. In August, the debt-ceiling debacle led to escalating tensions in Washington; however, debt debates are nothing new. As Adrian Cronje, Balentine’s Chief Investment Officer, pointed out in “Til Debt Do Us Part?,” the subject has been a source of contention spanning all the way back to the founding fathers. Indeed, the debt ceiling had been raised hundreds of time before, just without all the political posturing that occurred over the summer. Citing a need to gain control of government spending, partisan politicians threatened not to raise the debt ceiling limit, which would have left the U.S. unable to pay the interest on its debt and jeopardized its pristine credit rating.
Though Washington did end up raising the debt ceiling, the media attention surrounding this normally routine procedure caused many to question the U.S. government’s ability to act as a unified body. After the markets closed on Friday, August 5, Standard & Poor’s (S&P) downgraded U.S. debt, saying that our elected officials’ failure to agree upon steps to reduce spending and pay down debt caused the U.S. to lose its coveted AAA rating. In the ensuing days and weeks, investors dealt with heightened volatility, talks of another economic stimulus plan by the Fed, and the DJIA’s worst day since the height of the financial crisis in 2008. The same down-to-the-wire negotiations and politicking that led to the downgrade once again haunted Washington in the fourth quarter. Only this time, the deadline came and went with no compromise reached on where spending cuts would occur, thus setting into motion automatic cuts that will begin starting as early as this year.
Similar debt and governmental crises occurred in the Eurozone, most noticeably in Greece. In what became “A Bad Case of Déjà Vu,” solvency problems that initially arose in 2010 once again came to the forefront. Despite initially balking, the EU has thus far enacted the necessary structural reform to ensure that the single currency system will remain a viable proposition; however, the Eurozone’s central problems have not yet been resolved.
As we enter 2012, we expect Congress to remain trapped in its short-term political cycle and frozen in a state of inaction until the election is over. Similarly, the Eurozone will have a long road to recovery. Governments in both Europe and in the U.S. must finally be willing to balance the short, medium and long-term priorities required to deliver long term sustainability. While we wait for the developed world to emerge from the intense deleveraging cycle, we believe global bonds offer a potentially more prudent choice for U.S. investors searching for yield within the Safe Building Block. If developed economies catch the “Japanese disease” of even lower real interest rates, global bond holders still stand to benefit. However, if real rates begin to rise because of further concerns about the U.S.’ declining credit quality and the U.S. dollar is driven lower, global bond holders should be better protected.
