While aggressive monetary policy has been the most important catalyst for stabilization and rising asset prices in the past few years, fiscal policy should take the lead in 2013. Combined with continued easy monetary policy and improving economies both here and abroad, this new fiscal policy transparency should help to spark a long-awaited reallocation of capital for both businesses and investors. In other words, the big fix should begin. This is good news for the financial markets, equities in particular, and we have adjusted our recommended portfolio allocations accordingly. We continue to recommend a "get paid to wait" investment strategy, but we would overweight equities relative to fixed income and emphasize more growth and cyclical investments in the coming year.
FISCAL POLICY TRANSPARENCY IS THE NEXT CATALYST
Years of determined monetary policy experimentation by the U.S. Federal Reserve and now central banks in Europe, Japan and China finally appear to be close to achieving their goal of balance sheet repair and reflation. As we progress through this Great Experiment, where monetary policy — along with the profit cycle and investors searching for yield in a no-yield world — drives asset prices higher, particularly in equities, the "transparency" of fiscal policy should take the lead position.
We don't mean to suggest that fiscal policy is going to be pro- growth, particularly in the U.S. and Europe. Rather, we believe that greater transparency on the fiscal front alone (though not necessarily the specific policy within it) should be sufficient to give corporations and investors what they need to plan and act, to kick-start a reallocation of capital, in terms of rising capital expenditures and an investor shift from conservative short-dated low- or no-income-producing assets into more productive assets, such as equities.
In other words, in 2013, the big fix should begin, and it should occur around the world. The U.S. and Europe are already in the early stages, and China is beginning as well. Easy monetary policy, which was the catalyst for stabilization and rising asset prices when the credit crisis first broke, should continue, but now as part of the base — a given — that investors expect, along with continued healthy corporate profits and attractive equity valuations.
ECONOMIC OUTLOOK
Looking ahead, we expect a resumption of non-U.S. economic growth in 2013 and slightly better growth (around 2.5%) for the U.S. Europe should perform slightly better than many are expecting given their change in policy. Japan should benefit from more expansive monetary policy, and China's leadership should resume its pro-growth strategy plans. As a result, the growth curve in those parts of the world should increase slightly in 2013, and U.S. corporations should, once again, reap the benefits, given their high exposure to those parts of the world. This, along with continued improvement in housing and related businesses, should allow corporate profits to rise another 5% to 6% to another record high in 2013. Overall, U.S. growth is moving back on trend as moderate job growth and a falling unemployment rate help consumers while housing activity accelerates. We expect real gross domestic product (GDP) growth of around 2.5% in 2013, held back by a sluggish public sector.
While the overall number for U.S. growth isn't likely to change very much, the growth mix should alter. In 2012, profits primarily were led by industrials, manufacturing and technology. They should continue to experience strong profits in 2013, but with a larger boost from housing, housing-related industries and financials. Cheaper energy costs will help bolster the profits of U.S. firms in 2013 as well.
GLOBAL REBALANCING IS ALIVE AND WELL
Although economic growth is not where we would like, and ultra-easy monetary policy has yet to erase all of the built-up leverage, certain areas are prospering in this so-called "new normal." These areas just happen to be different from the areas that were in the middle of the last crisis and benefited from the rise in leverage. The new areas are across all market capitalizations and in a variety of industries. Some of the largest and most highly respected companies in the United States have been able to lower their costs of capital, maintain high margins, increase productivity, build high-quality products, and increase their profit streams as the developed world has been under growth pressure. Many have experienced record profits because of their exposure mix at the end-buyer level. A high proportion of their buyer base is in the growing parts of the world — namely, the emerging markets. This is the main difference between now and prior cycles, and it is part of our own "new normal" theme — global rebalancing.
In addition, the Federal Reserves's easy monetary policy, which includes the quantitative easing experiments, has allowed these companies to finance future operations through debt deals at the lowest rates on record.
The bottom line: Corporations — both big and small — are benefiting from global rebalancing even in the face of 'The Big Fix' in the developed markets. The U.S. profit cycle is evidence that this is already happening.
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