Fiscal View: Expert predicts a different, albeit still bumpy, 2012

With the inevitable volatility that will prevail, you might consider keeping a large portion of your portfolio in cash.

Christmas this year was a quiet occasion with my wife and 19-year-old son, just back from his first term at Bristol University. I judged, correctly, that he was not too old for a Lego Technic Supercar and we spent three days putting it together, blissfully detached from the financial world that was collapsing around us. But now back to the mayhem.

2011 was an extraordinarily eventful year and one in which investment was fraught with unexpected danger. We witnessed people in the Arab world rise up heroically against their autocratic rulers, cutting off oil supplies to the Western world. We saw the devastating earthquake and tsunami in Japan that killed thousands and brought exports to a standstill. These unpredictable events had significant effects on the supply of energy and components so vital to world business activity. Inevitably, profits and share prices fell. But the factor that dominated investment thinking most during 2011, causing enormous volatility in share prices, was dithering as politicians tried to solve the debt problems of the US and, especially those of Europe. Equity markets hate uncertainty. It is not surprising therefore that very few of them made gains in 2011.

The UK FTSE100 fell 2.2 per cent in 2011. The French equity market (CAC) and the German equity market (DAX) saw falls of 13.4 per cent and 14.1 per cent respectively while the euro ended the year at a 15-month low against the dollar.

Asia and Emerging Markets were no better, dispelling the theory that their economies are uncorrelated with those of the Western world. When the tide goes out, it seems that all the ships in the harbour fall. China's Shanghai Composite Index lost 21.7 per cent in 2011 as its government imposed tighter curbs on lending to slow down the economic growth. The Indian market was slightly worse. The Sensex, Bombay's Stock Exchange's equity index, fell 22.2 per cent during the year - its second worse performance in a decade. And if you had invested in this market using your hard-earned US dollars or dirhams, you would have seen an additional foreign exchange loss of 16 per cent. That's a total of 40 per cent down for a US dollar investor. The Indian rupee was, in fact one of the worst performing currencies in 2011.

Japan's stocks lost 17 per cent in 2011, which is not surprising given the huge effect of the tsunami and the subsequent reduction in the country's nuclear power capacity.

The only significant glimmer of hope in 2011 was the resilience of the US economy. Despite poor economic activity in the rest of the world; despite its own enormous debt problems and the downgrading of its credit rating by Standard & Poors, the US was the only mature market to show a gain in the year- albeit a small one. The S&P500 was up slightly at 2.2 per cent.

Gold performed well, as it often does in times of crisis, rising in September to an all-time high of US$1,921 (Dh7,056) per ounce in September. Since then it has fallen back to finish the year at US$1,531 per ounce but was still 11 per cent up over the year. Gold has shown in 2011 that it is not quite the safe haven that it is claimed to be in times of crisis. When investors believe that it is overpriced, they will move to a safer haven, as they did in the latter part of the year.

The star performers for the average investor in 2011 were government bonds. US treasury bills returned around 9.9 per cent in 2011 and those that were inflation linked returned around 14 per cent. UK gilts generated over 16 per cent. US investment grade corporate bonds and emerging market bonds also did well with average returns at 8.2 per cent and 8.7 per cent respectively.

And what of 2012? It is customary, at this time of year, for economists and fund managers to make predictions for market performance over the coming 12 months. But I have to say, on the basis of last year's efforts, that they are unlikely to be close to the truth. (Most analysts were predicting growth in the world's equity markets in 2011). But I came across an interesting article by Chris Wyllie, chief investment officer, at Iveagh. This company was originally set up to manage the Guinness family fortunes but now offers asset management services to other private clients. I will leave you with his controversial predictions for 2012:

• The biggest issue will remain deleveraging, in both banks and governments. Global investors will wake up to the fact that the biggest deleveraging story of all - the US government - is only just beginning. This will test their faith in US equities as a safe haven.

• The three-year trend of US equity outperformance versus Europe will start to reverse. The biggest policy mistake of 2011 was to squeeze European bank balance sheets while squeezing public spending and the growth consequences of this will reverberate around the world.

• The biggest disappointments will come not from Europe, nor the US, but from Asia, with China taking centre stage when it comes to worries about global growth.

• By late spring, investors will be confronting the threat of a global recession.

• With the presidential election close at hand, there will be (misplaced) concerns that Fed action may be inhibited. The dollar will soar.

• Casualties will include sterling and commodity-related currencies such as the Australian dollar. Gold will also suffer, with fears that the 10-year bull run may be over.

• Greece will leave the euro, which prompts a selling climax before equities finally find a floor and start to rally.

It makes you think doesn't it? If you believe in his predictions and the inevitable volatility that will prevail, you might consider keeping a large portion of your portfolio in cash and wait for the buying opportunities that will surely follow.

Bill Davey is a wealth manager at Mondial-Financial Partners, Dubai. Contact him at [e-mail] or [e-mail].