For anyone who makes money by making sense of financial markets, 2011 was a confounding year.
Whether
it was Europe's seemingly intractable debt crisis, uprisings in the
Middle East or the political bickering and growing debt burden that cost
the United States its AAA credit rating, investors had to be more
nimble than ever to stay ahead of swiftly changing sentiment.
 |
AP
|
When
the history books are written, 2011 may go down as the year when
political risk trumped economics, earnings and interest rates as the
main force driving capital markets.
"I
can't remember a year when politics had such a big impact on capital
markets," said Ron Florance, head of investment strategy at Wells Fargo
Private Bank, which oversees $157 billion in assets. "Maybe during the
crash of 1987, but that lasted for a day. This has lasted for 365."
Just
ask Tony Crescenzi, a portfolio manager at PIMCO, operator of the
world's largest bond fund. For most of his 28-year career, a successful
strategy boiled down to making the right call on the U.S. economy.
Not anymore.
"Now
you've got all these other things in the mix. I've had to use a lot
more of my time to learn about a lot more things," he said, noting that
German, Greek, Chinese and other foreign newspapers are now part of his
daily reading regimen.
Few expect things to be different in 2012.
Russell
Napier, strategist at CLSA Asia Pacific Markets, a Hong Kong-based
brokerage, said he fears a European banking crisis next year that could
lead to the nationalization of some banks and push both Europe and the
United States into recession.
"The
bigger the politics quotient, the more volatile the markets," Napier
said. "And it isn't going to get any better next year."
'MIND-NUMBING VOLATILITY'
What
the intersection of politics, economics and finance has meant for
investors this year is not immediately apparent. The benchmark S&P 500 index [.SPX
1265.33
11.33
(+0.9%)
] looks set to finish the year roughly where it began.
The
euro, meanwhile, has shed just 2.5 percent against the dollar—hardly
what one would expect from a currency some investors fear may not be
around much longer.
"But that doesn't begin to describe what investors went through," Florance said.
According
to Jeff Rubin, an analyst at Birinyi Associates, the average daily
spread between the S&P's high and low in August was 3.39 percent.
That's
below the vertigo-inducing swings seen after Lehman Brothers collapsed
in 2008 but certainly volatile enough to make for very uncomfortable
trading.
After
political bickering over raising the U.S. debt ceiling brought the
United States to the brink of default in August and Standard &
Poor's stripped the country of its gold-plated AAA rating, stocks went
into free-fall, shedding some 12 percent by the end of September.
Then in October, they abruptly reversed course, rising more than 10 percent.
"It was mind-numbing volatility," Florance said. "Every single headline created a stunning response."
To
be sure, 2011 generated a lot of market-moving headlines. A devastating
earthquake in Japan, regime change in Egypt and Libya, and Europe's
constant attempts to get ahead of a worsening debt crisis sparked wild
fluctuations in stocks, commodities, bonds and currencies.
On
top of that, activist central bank policies in developed economies and
government intervention in foreign exchange markets have kept investors
on their toes.
Even
now, with barely a week left in 2011, investors can only guess at
whether U.S. lawmakers will agree to extend a payroll tax cut for 160
million workers.
Economists and businesses fear expiration will hurt an already-fragile economy.
There's
even less clarity when it comes to Europe, where multiple attempts to
prevent a debt crisis from spreading and to reassure markets have
failed.
As the
year winds down, borrowing costs for Italy and Spain are close to their
euro-era highs and worries about the European banking system remain
elevated.
"It's a
microcosm of the entire year," Crescenzi said. "Most sensible people
would have expected policymakers in the U.S. and Europe to have taken a
different approach, because the approach they chose was a big negative
for risk assets."
More
worrisome, Chinese growth appears to be slowing, which would be
arguably worse for big exporters dependent on demand from what is now
the world's second-largest economy.
Furthermore,
that may prompt Beijing to put the brakes on recent yuan appreciation,
said Karl Schamotta, currency strategist at Western Union Business
Solutions.
That would make it harder for struggling Western economies to boost growth through increased exports.
DEFYING LOGIC
Some
of the industry's surest shooters lost their focus this year. Bill
Gross, co-chief investment officer of PIMCO, bet heavily against
Treasuries, which turned out to be a top performer in 2011.
Investors responded by yanking $10.3 billion from PIMCO's Total Return Fund [PTTRX
10.85
-0.03
(-0.28%)
] in the year to November, according to fund tracker Morningstar.
FX Concepts, one of the largest currency hedge funds with $4.3 billion in assets, was down 17.8 percent through October.
"Wise
old head or not, these are very difficult market conditions to trade,"
said Alan Wilde, head of fixed income and currency at Baring Asset
Management in London, which oversees $50 billion in assets.
Of
course, a 10-year Treasury yield around 2 percent despite a U.S. credit
downgrade and a budget deficit running at nearly 10 percent of output
would seem to defy logic, but that's the kind of year it has been.
"I
have sympathy for Gross and others who believed bond yields had dropped
too far and bet on making money from rising yields," Wilde said.
"Longer term this is absolutely the right trade to have on. If it is
not, then financial markets are doomed, as low short and long yields
will be a precursor to a global depression."
The trick, as always, is getting the timing right.
Colin
Lundgren, who helps oversee $171 billion as head of fixed income
strategy at Columbia Management in Minneapolis, said manageable
inflation, slow economic growth and Europe's ongoing crisis will
probably limit how far Treasury yields will rise in 2012.
If
Europe does get its act together and U.S. growth and inflation rise
more than expected, "that could spell a pretty ugly scenario" for bond
bulls, he said.
"With
the absolute level of rates so low and consensus leaning so strongly
the other way, you just have to worry that we will eventually have a
year of reckoning," he said. "Maybe 2013 is the unlucky number."
Copyright 2011 Thomson Reuters.
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