After the Pause

As 2011 began, we expected it to be a flattish year of volatility, frustrating bulls and bears alike—a “pause that refreshed.” As the new year begins, we’re past the pause and expect the bull market to resume with gusto.

Steep volatility and overall flattish broad market returns in 2011 helped shake out positive sentiment—leaving sentiment seemingly more uniformly dour now. Headlines fret tapped-out consumers, sovereign debt, a Chinese hard landing, political wrangling, too much stimulus, too little stimulus, etc. In our view, this is a bullish feature, providing stocks a wall of worry to climb.

And beyond just sentiment, there are ample underappreciated positives. The global economy is growing and should continue to do so. Emerging Markets, particularly emerging Asia, should be a bright spot. Firms are lean, healthy and growing—we expect to see continued profit and revenue growth. We think this all provides equities a strong tailwind.

Another bullish feature is, in this election year, America either reelects a Democrat or newly elects a Republican. Historically, either outcome has generated strong equity returns on average in election years—which ideologues from either party will find hard to fathom.

That’s not to dismiss the challenges global markets and economies face this year—primarily continued European difficulties (as we’ve already seen). The current prevalent concern is Italy—which represents about 59% of the PIIGS debt that must be rolled over this year. But clarity will come soon as Italy has key debt auctions early in the year—almost half of its 2012 debt auctions occur in February, March and April. Very early auctions have already gone fine—better than expected. Overall, we think results will best doomsday expectations.

While many are focused on the risk of an unexpected PIIGS default (a low likelihood in our view), we see attempts to “fix" sovereign debt woes by quickly and radically implementing new regulatory and/or accounting schemes as a greater risk. However, thus far, European officials and politicians have largely continued kicking cans down the road—a response that seems largely appropriate to us. Continuing in that manner also allows the private sector time to find solutions (and as frequent readers will know, our preference is for private sector as opposed to government-derived solutions).

Furthermore, history shows a region even as large as the eurozone can be overall weak and the rest of the world fine—not only that, but it seems likely eurozone weakness continues to be concentrated primarily in those countries already known to be struggling (namely, the PIIGS). One final eurozone point: This year marks the third in which eurozone news has dominated headlines. But positive or negative, sentiment surrounding any single issue typically eventually spends itself. And for that reason, we think it likely eurozone sentiment improves this year.

Overall, we anticipate 2012 to feature strong equity returns, particularly in economically sensitive areas—as the bull market continues climbing the proverbial wall of worry and now long-in-the-tooth fears prove to pack less punch.