Equity markets will bounce back in 2012

The legendary baseball manager Yogi Berra famously quipped, “It’s déjà vu all over again” in the early 1960s, following back-to-back home runs from Mickey Mantle and Roger Maris.

Many financial market pundits and prognosticators are channeling Yogi Berra as we head into 2012. The consensus is that 2012 is going to look a lot like 2011, dominated by debt woes in the U.S. and Europe, a downturn in the world’s economies, and finally, depressed equity markets.

The naysayers would have you believe the three Ds of economic gloom — debt, downturn and depression — are not only staying for dinner, they’re spending the night, too.

They’ve got it wrong. On the contrary, expect 2012 to mark a turnaround in equity markets and for opportunistic investors to reap the rewards. Smart investors will make money. The markets have been beaten up in the latter half of 2011 — and therein lies the value creation for stock pickers, and, by extension, mutual fund investors.

A look at 2011 Equity returns were looking strong through the winter and spring until political shenanigans in the U.S. and Europe side-swiped the markets. International debt woes sparked a sickly summer and fall on the markets.

In Washington, D.C., the Obama White House and the Republican-dominated Congress remain at loggerheads on debt reduction. The crisis is both sad and comical – at press time, Republican lawmakers faced a torrent of criticism after blocking a compromise plan to extend a tax break for 160 million Americans.

Meanwhile in Europe, the leaders of the euro zone are struggling to resolve the fiscal woes of their weakest members, particularly Greece and Italy. In late December, the European Central Bank weighed in, providing nearly half a trillion euros (about $664-billion) in cut-price loans to more than 500 banks to ease credit crunch fears.

With gold and fixed income assets like government, corporate and global bonds besting the returns of weaker equities, 2011 was a defensive year. All major stock indices were in negative territory, including Asia, Europe, the emerging markets and Canada’s own resource-heavy S&P/TSX Composite Index.

U.S. stocks were a noteworthy exception with the Dow Jones Industrial Average up about 4% in Canadian dollar terms. The U.S. large cap equity index is well-diversified and less sensitive to business cycles when compared to the resource-rich TSX.

The good news is… Volatility is returning to normal levels. The VIX, the ticker symbol for the Chicago Board Options Exchange Market Volatility Index, is a popular measure of the implied volatility of S&P 500 options. It’s often referred to as the fear index as it is a forward-looking gauge of the volatility and expectations impacting the world’s biggest equity market.

The VIX’s long-term average is 20. It peaked at a whopping 81 in November of 2008 in the midst of the subprime mortgage credit crisis that humbled the titans of Wall Street. The VIX retreated through 2009 and 2010 and then climbed again this past summer, spiking at 48 in August.

Near the close of 2011, the VIX had retreated to the low 20s, suggesting volatility has subsided and, slowly but surely, we will return to some normal equity trading patterns. Roiling daily markets with steep peaks and valleys are poisonous when it comes to investor confidence.

Markets abhor uncertainty while good news stokes gains. After months of baby steps, the euro zone can be expected to finally reach a definitive debt agreement in the first half of 2012. Europe is a life boat and it is in the interest of all nations, including Italy, Greece and the reticent United Kingdom, to keep the ship afloat. Stay tuned.

Mixed views on the U.S The debt stalemate may fester through 2012 and we may have to wait until 2013 for any significant developments. But a double-dip recession in the world’s largest economy is looking increasingly unlikely. Corporate America is cash-rich, retail spending is up, consumer confidence is improving, gas prices are falling and businesses are restocking shelves and warehouses. These are all positive indicators the U.S. is on the mend.

Emerging economies The outlook remains positive for the emerging economies of Asia, Latin America and South America. Collectively, they have made huge strides over the past decade to restore economic growth and improve corporate balance sheets.

Debt-to-GDP levels in emerging markets are a fraction of the world’s more mature economies and fast-growing middle class means consumer spending will remain strong. Expect emerging markets to speed along at about 5% to 8% growth in 2012. The Chinese economy may cool slightly, but will nevertheless record a heady 8% to 9% growth next year.

Nowhere to go but up The 2011 correction has presented some excellent buying opportunities for those “buying on the bottom.” The share prices of some of the world’s best blue-chip companies may be down, but the fundamentals that drive long-term returns remain solid. These well-managed global companies are sitting on billions in cash; dollars that will fund future growth, share buy-backs or dividend increases. This is all good news for prospective investors.

It’s back to basics in 2012 Dismiss the short-term market noise and remain focused on long-term goals. A well-diversified investment portfolio can take advantage of new opportunities in emerging markets. Dollar-cost averaging – making small investments on a month-to-month basis – will bring long-term stability and smooth out the market’s highs and lows.

Advice is a key component of our dynamic marketplace, and Canadians overwhelmingly choose to invest and manage their financial decisions with the help of advisors. Without the counsel of a professional financial advisor, investors can be influenced by a wide range of issues.

Here’s another great Yogi Berra quote that hits the point home: “If you don’t know where you are going, you might wind up someplace else.” In these uncertain and complicated markets, some good financial advice will ensure you reach your goals and don’t end up someplace else.

Don Reed is lead manager of the Templeton International Stock Fund and CEO of Franklin Templeton Investments Corp.