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Goal: Global Opportunity Asset Locator

Lower growth expectations, but much is priced

This week we revised our economic and market forecasts. We now expect 3.5% global GDP growth in 2012, a slowdown in US GDP growth to 0.5% qoq annualized in 1Q2012 and a very mild recession in the Euro-zone with -0.4% growth qoq annualized in 4Q2011 and 1Q2012. This is followed by a reacceleration of growth through the rest of 2012. In our view, markets have already priced a scenario which is worse than the one we forecast, but, in many places, not a broader-based or much deeper recession.

The sovereign situation is the key risk factor

This pricing reflects concerns about the European sovereign situation and the tail risks it creates. A full resolution to this involves a structural reform process which will take a long time to come to fruition. In the meantime, a lowering of the perceived tail risks on the back of further policy intervention is the best that can be hoped for. Given current pricing, we believe this alone could give a significant positive return for risky assets, even though it would not resolve all the problems. In the absence of intervention, deteriorating growth and tail-risk concerns which continue to build are likely to lead risky assets sharply lower.

Near term neutral, long term pro-risk

As a reflection of this wide range of outcomes, with the final result being dependent upon a political process which is hard to forecast, we feel the Sharpe ratio on risky assets is not good from either an overweight or an underweight perspective in the near term. We therefore overweight cash, neutral weight commodities, corporate credit and equities and underweight government bonds. Over a 12 month horizon there is more time for a policy response, we will see a growth rebound on our forecasts, and valuations start to matter more. Consequently we have more confidence and overweight commodities and equities, neutral weight corporate credit and cash and underweight government bonds.

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