Stocks Growing More Attractive - Beyond Short-term Risks

What Next for Europe?

What Next for Europe?

The market decline that has occurred over the last couple of months has largely been attributed to escalating concerns over the European debt crisis and we believe that Europe remains the chief variable in determining the future direction of the global economy. If Europe's debt crisis remains reasonably well contained, the world should continue to grow at a modest pace with the United States doing relatively well; if debt contagion becomes chaotic and uncontrollable, it would be an entirely different story. Our view continues to be that the former scenario is the more likely one.

Policymakers in Europe are employing a number of strategies to combat the crisis and the growing political uncertainty, including efforts to influence the Greek elections, reinforce firewalls should Greece exit the euro zone and promote pro-growth policies regardless of what happens with Greece. Additional measures such as developing a pan-European deposit insurance program or directly recapitalising Europe's banks do not appear to be likely at this point, but remain options should the situation deteriorate.

The European Central Bank continues to actively promote liquidity and has been expanding its balance sheet. The ECB has come a long way from where it was a couple of years ago when it was focused almost exclusively on fighting inflation and seems committed to doing what is necessary to help stem the crisis.

US Recovery Continues, but Debt Issues Loom

Investors are also remaining focused on the state of the US economy. The data has been mixed in recent months, but continues to point to a modest recovery. The business sector remains a source of strength, consumer uncertainty appears to be fading somewhat and we are also seeing some improvements in the housing market. Additionally, liquidity and credit conditions continue to improve in the United States, with bank loans increasing in recent weeks. Much hinges on the jobs market and we are expecting to see payrolls growth continue to rebound modestly, which should help boost the overall economy.

There are a number of questions over the future direction of monetary policy in the United States. Our view is that the Fed is likely to remain on hold and that an additional round of easing (ie, QE3) is not likely unless we see more compelling evidence of an economic slowdown.

One major uncertainty in the US outlook is the so-called "fiscal cliff." Last week, the Congressional Budget Office warned that the US economy would likely fall into a recession if all of the tax increases and spending cuts set to take effect on January 1, 2013 actually come into effect. We still believe that at some point elected officials will come together and delay and/or restructure some of the scheduled tax and spending policies (possibly during a post-election lame duck session of Congress) but the sense of uncertainty over this issue remains a negative for the economy and the financial markets.

Risk Assets Remain Compelling

Our view continues to be that global economic growth will remain acceptable with conditions gradually improving in the second half of the year. Leading global economic indicators are rising, the US recovery has grown more firm and earnings momentum is positive. There is still quite a bit more that needs to be done on the part of policymakers around the world to take the necessary steps, but the trends are pointing in the right direction.

Given our view that the European debt crisis should remain reasonably well contained and our belief that the US recovery remains on track, our outlook for risk assets continues to be a positive one. The combination of the rising equity risk premium, falling stock prices, improving corporate earnings and lower Treasury yields means that stocks have become quite cheap relative to bonds. Assuming that the world is not headed for a renewed deflationary spiral, there is little doubt in our view that stocks are poised to provide superior long-term returns over bonds given their current levels.

by: Investor Today

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