2013: European policymakers will ‘spread out’ the pain of the Continent, says BlackRock

Throughout 2013, changes in government policy will directly translate into changes in asset returns, and the legacies of the financial crisis, such as low economic growth, declining tax revenues, deleveraging, rising unemployment, record-low bond yields, and government transfers that prop up corporate profits will add up to a central role for policy, according to BlackRock’s outlook for 2013.

According to the firm, European policymakers are looking to spread out the pain of the Continent’s necessary fiscal tightening by extending deadlines for fiscal austerity, a positive development that may arrest Europe’s downward economic growth spiral.

Meanwhile, in the US, investors are still not weighing heavily the potential impact of the fiscal cliff.

“Short-term market volatility has been eerily low compared with political uncertainty that is at levels hit during the depths of the financial crisis in 2008,” said Russ Koesterich, BlackRock’s Chief Investment Strategist.

“The answer may be easy monetary policy and liquidity. If financial markets are underwritten by central banks and governments, there is no need for asset prices
to reflect any worries.”

With so much noise, it is difficult to invest with conviction, BlackRock said.

“We generally like equities for 2013. But we are not enamoured,” said the firm.
According to BlackRock’s investment institute, some investors are sacrificing safety and liquidity just to gain a couple of basis points of yield.

“Markets may pre-empt the Fed, and trigger a rush out of fixed income for the exit to equities. Safe-haven fixed income assets may well provide disappointing returns from here,” BlackRock said.

Quality businesses and dividend stocks would likely underperform leveraged companies
as the flow out of income could result in a temporary “dash for trash”.

Casualties would be ‘safe’ assets such as government bonds of the US, UK, Germany and other Eurozone core countries. It takes just a miniscule rise in yield to trigger sizable bond price losses.

To prepare for such a day, it is important to identify areas of value in income investing – and pockets of overvaluation or risk.

Above all, it will be critical to be cautious across the entire investment
landscape in the year to come.

Conflicts in the Middle East have been the focus of global foreign policy for much of the new millennium, and have the potential to cause an oil price spike, or “energy shock.”

Another risk is China’s territorial dispute with Japan and other nations over uninhabited but resource-rich islands in the South China Sea. A major terrorist attack is a third risk.

Other risks include a North Korean provocation against South Korea or Japan, which
may act up to (temporarily) regain the global spotlight and to test China’s new
leadership.

Here are the five key points for 2013 identified by the BlackRock Investment Institute

1. We have become more upbeat about the prospects for risk assets and stabilising
economic growth (albeit at low levels). Low expectations = potential upside
surprises.

2. The US economy should gain momentum and help boost global growth – IF
Washington can avoid the “fiscal cliff” and compromise on a sustainable budget.

3. Many investors lack conviction in markets where risk taking is often punished and
trends last a skinny minute. Rome – and confidence – was not built in a day.

4. The era of ultra-loose monetary policy may draw to a close, challenging “safe”
fixed income assets and heralding a shift toward equities. Safety = new tail risk.

5. Income investing works in a zero-rate world – but the hunt for yield has narrowed
valuations between top-quality and not-so great income assets. Take out the
garbage.

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