Four things that could upset the consensus in 2013

Kanika Saigal, Euromoney Skew
Published on:

Lower growth, yen weakness, Fed rate hikes and a jump in volatility are some of the contrarian risks for 2013, according to Bank of America Merrill Lynch analysts.

No one really expected a good year. The eurozone crisis drudged on, markets shuddered globally as they prepared for the upcoming fiscal cliff, conflict in the Middle East threatened to escalate further, China’s economy slowed and rumours of a hard landing didn’t do much for investor confidence. However, despite all the doom and gloom, Bank of America Merrill Lynch (BAML) analysts point out that 2012 was at least a good year for some. The resounding winner – contrarian trades:
“Few expected the best-performing bond markets to be in Greece, Portugal and Ireland; financials to be the best-performing equity and the IG bond sector and tech to be the worst; or for volatility to be in a bear market.”  

And according to BAML, the surprises won’t end as 2012 comes to a close. Here are four things that could surprise us again in the new year. Hopefully, the global economy will pick up in the second half of 2013, after a resolution to the fiscal cliff and Spain asks for formal help from the European Central Bank, says BAML. 1. Higher ratesThe Federal Reserve recently announced that interest rates will continue to be suppressed so long as the rate of unemployment remains above 6.5%, implying that low interest rates in the US are gradually helping put people back into employment. However, interest rates in the US have been near zero for four years. And unemployment levels have remained at record highs, floating around 9% and 10% in the period between 2009 and 2011. Data from the Bureau of Labour Statistics for November, however, showed that unemployment had declined to 7.7% – the lowest rate since January 2009. Perhaps the US is on the right path after all. But higher interest rates as early as 2013 will be a genuine surprise, says BAML.
“Bond funds have seen dramatic inflows this year, with EM debt fund flows accounting for a remarkable 25% of AUM. The ability of fixed income funds to attract so much money is indicative of investor expectations for rates to remain very low.

“We find the change in the Fed’s 'exit strategy' from its zero interest rate policy from late-2015 to an economic threshold of unemployment below 6.5% (and manageable inflation) to be very interesting. In our view, this brings into question the expectation that high liquidity is here to stay, and is perhaps a reason why gold prices have struggled this year. “Currently, no one is positioned for higher rates. But if we get a disorderly great rotation, whereby yields rise rapidly in response to stronger-than-expected economic growth, then many leveraged areas of the fixed income market (such as EM) are at risk.

“One thing to watch for next year is the relationship between yields and the dollar. A disorderly rotation would likely coincide with higher rates and a weaker dollar.” 

2. Lower growth, driven by the US consumerAnother surprise, says BAML, would be weaker-than-expected growth, particularly if it is the result of a weaker American consumer.
“Global growth expectations rose to the highest level in 22 months and regional and sector positioning is skewed towards segments of the market that should benefit from stronger consumer spending. But if that doesn’t come to pass, portfolios will likely have to be re-allocated.” 
Nevertheless, BAML is confident that consumer spending will pick up next year and will reach at least 2% at the end of 2012, up from 1.3% in January 2013. In addition, BAML reckons that the housing market has bottomed out, so investing in the property sector shouldn’t be as scary is it was during the past year. Borrowing costs are low and house prices are cheap, adding incentives to buyers. Indeed, the National Association of Home Builders/Wells Fargo Index of builder confidence has increased over the last five months and at the end of the first quarter of 2012 it touched its highest level in five years. However, this is not to say there isn’t any danger:
“A big risk is if we fail to see a clear resolution to the fiscal cliff, and that the can gets kicked down the road, causing fiscal uncertainty to linger. Consumption would likely weaken amid expectations for higher taxes, spending cuts and an increased cost of living.” 
3. Yen debasement: ¥113/$ in 2013? Japanese equities have been pretty strong of late and the NKY rose from 8,660 in mid-November to more than 10,000. And despite expectations for a weaker yen, BAML still believes that Japan will be a favourite contrarian trade:
“Japan is the ultimate anti-deflation trade. Reasons to buy Japan: a weaker yen is good for stocks; the FMS allocation to stocks in the region recently fell to a 3.5 year low; stocks in the region are 50% cheaper than other DM; Japan is just 7% of the global equity market – down from 44% in 1988.” 
4. Volatility resurfaces, or the era of macro is over According to BAML, one of the biggest surprises this year was the bear market in volatility.
“Massive liquidity programmes from global central banks trumped tail risks. A rise in volatility next year would not be a surprise, particularly in the FX market. With policy rates around the world close to zero, the new automatic stabilizer is FX." 
However, for BAML, the biggest surprise in 2013 and beyond is that the era of tail risks is coming to an end:
“This indicates that we are close to being in a differentiated/stock picker’s market.” 
So there you have it. The surprises to look out for next year. Don’t say we didn’t warn you.