On The 'Uniqueness' Of 2012's Equity Performance
Credit and equity markets (should they avoid a catalcysmic year-end slump back to reality) are heading for much better results that one might have expected. As JPMorgan's Michael Cembalest somewhat passive aggressively notes, this year looks to be a reward to those who stuck to normal investment allocations despite the macro issues in play, and despite low global economic growth.
One way to visualize 2012: the red dot in the chart, which shows global GDP growth and equity market returns each year since 1970. There’s normally a connection between growth and equity returns, with the exception of the dots in the box, which are low-growth equity rallies. If we remove post-recession rallies and rallies based on significant interest-rate declines; what we are left with is the conclusion that 2012 is kind of unique: a low-growth year with double-digit global equity returns not based on a recession rebound or a bond market rally.
The only other was 1998. Of course, a huge factor this year was the European rescue. What about 2013?
Without the usual catalysts for a low-growth rally, a stronger recovery in global growth would probably be needed to generate similar equity returns. As things stand now, the pieces are in place for a modest improvement in growth in the US, China and EM Asia, but less so in Europe and Japan. At first glance, a 3% global growth rate would match up with high single-digit global equity markets returns in 2013.
A fiscal “grand bargain” in the US could result in multiple expansion which would drive returns higher. Multiples of 13.6x on the S&P 500 have room to rise before becoming overpriced (at least from a historical perspective).
How likely is this “grand bargain”? Recall the Republican Presidential debate in which some candidates pledged to eliminate or seriously constrict the Environmental Protection Agency. A proposal like this2 reflects the fact that after the Budget Control Act, there really isn’t that much non-defense discretionary spending left for politicians to fight over (by 2017, it will be at the lowest level in 50 years).
On government spending, the grand bargain is mostly about cutting entitlements, which runs counter to voter sentiment.