First Quarter 2012 Market and Economic Outlook
Posted April 16, 2012
Global equity markets are off to one of their best starts in recent history. In our year-end 2011 report, we mentioned that equities were set up for a potentially strong year in 2012 if policymakers in Europe could get ahead of the credit crisis. Our support for this view was that U.S. corporate operating earnings were up 15 percent in 2011, and equities were flat for the year, thus making stock valuations more attractive.
At the end of 2011, equity valuations were in the lowest quartile over the past 20 years, and equities were the cheapest relative to bonds in the past 30 years. Eventually, money typically flows into the more attractively valued asset class. After four straight years of record flows into bond funds and out of equity funds, a massive imbalance was beginning to unfold. We may now be in the early stages of a large rebalancing trade, where portfolio managers and investors begin to sell their bonds and re-allocate the proceeds into equities.
Bond investors are getting a taste of the dangers in the bond market as we are coming off record low interest rates. The thinking is that if bond investors continue to see losses on their investments as rates rise, they will begin to sell their bond positions and re-allocate some of the proceeds into equities and other assets that protect against rising inflation.
We see three major factors supporting the potential view that a reflationary situation may now be at hand. This may indicate a great re-allocation trade.