The year 2012 and the dreaded “fiscal cliff” drama culminated with a political fizzle while stock prices rallied robustly. Unfortunately, the fiscal fight continues.

As we expected, the GOP avoided/postponed the battlefield of the debt ceiling – which carries too much financial market and political risk – and will use government spending authority, expiring at the end of March, as the lever to force an agreement emphasizing spending cuts. In this scenario we could well see a temporary government shut down and even sequestration – automatic spending cuts nearing $1.2 trillion hitting both defense and non-defense programs.

Tony Caxide

North America

Tony M. Caxide, CFA®

Chairman - Senior Investment Council

In each of the last four years, the U.S. stock market generated positive returns, and in three they were double-digit (based on S&P 500 total return data). Yet over half of investors polled thought it was flat to down, leading them to withdraw $250 billion (net) from equity mutual funds during a full-fledged bull market. Not exactly good timing.

Investors’ patience will again be tested by the frightening headlines that the next few months may bring (see Overview above). But most probable scenarios result in some deficit and spending reductions, which will restrain economic growth but be seen by the markets as a necessary salve to gradually reduce our federal deficits.

Jeffrey G, Wilkins


Jeffrey G. Wilkins,

Deputy Chief Investment Officer

Japan’s new leader, Prime Minister Shinzo Abe, quickly set a new tone of aggressive government stimulus to encourage growth via exports and end deflation. His rhetoric was enough to weaken the yen even before he took office. More recently he announced a $224B stimulus package that is designed to add 2% real growth in GDP. Abe successfully pushed Japan’s historically independent central bank to raise its inflation target to 2%. Recent economic releases have been weak, but do not take into account any of the yen’s recent weakness, which should help growth. So far markets have shrugged off the risks of more debt for Japan, which already has the highest debt-to-GDP ratio of any industrialized country, and appear to be betting on recovery and rising profits.


Jeffrey G. Wilkins,

Deputy Chief Investment Officer

Signs of improvement are appearing on Europe’s horizon, although back-to-back negative GDP reports in the second and third quarters have stolen the headlines. However, an accommodative monetary policy by the European Central Bank (ECB), and central banks around the world, has helped, driving bond rates down. This has been most important in Italy and Spain. Also offering promise, renewed signs of global economic expansion appear to carry the potential for increased demand for euro zone exports.

While European financial markets have gained confidence, prices still imply a healthy level of skepticism. The ongoing commitment of European leaders and the ECB to maintain unity and monetary stimulus, respectively, will likely repair the economy and financial markets, though the road will be bumpy.


Jeff (Shengde) Liu, CFA®

Managing Director, Portfolio Management

After an exaggerated jump in the third quarter, the UK economy definitely cooled down in the fourth. A triple recession is possible. Although UK manufacturing activity hit a 15-month high in December, Britain’s dominant service sector shrank for the first time in two years. Wage growth slowed in recent months and inflation continues to show upward pressure. Higher inflation also has resulted in lower consumer confidence and stagnating retail sales of late.

Nevertheless, we believe GDP contraction will be shallow. UK’s home prices remain stable and the mortgage market continues to improve. The loosening monetary policy should continue to provide a cushion to the economy and the new BOE governor to be, Mark Carney, brings hope to the market. This has led us to bring our previous underweight position up to neutral in our Opportunity Growth (3%) and Dynamic Growth (5%) strategies.

Emerging Markets

Jeff (Shengde) Liu, CFA®

Managing Director, Portfolio Management

Emerging economies have shown signs of improvement, as developed markets stabilize and the inflation threat is contained. Chinese Manufacturing PMI has stayed in growth mode since October and the service sector also continues its expansion. ASEAN countries like Indonesia and some Latin American countries like Mexico, which were insulated from the global slowdown in 2012, are keeping on the right track. As strikes end, South Africa shows signs of stabilization in the manufacturing and mining sectors.

We believe that earnings in EM economies (measured by the MSCI EM Index) can grow at about 6% in 2013. Even after the recent rally, EM stocks are still inexpensive compared to their developed-market counterparts, leading us to increase emerging-markets allocations in our growth-oriented strategies.