A trade for 2012: sell Europe, buy the US

It’s been some year.

Stock markets across the globe have performed woefully. Developed markets did better than emerging ones, but the fact is your money would have been better off in a savings account than in the average index tracker this year.

Gold did well – it peaked mid-year, but in terms of annual performance, it still thrashed just about any other asset class around.

And the defensive stocks we’ve been tipping all year have done well. Neil Woodford’s Edinburgh Investment Trust (LSE: EDIN) – which invests mainly in those sorts of stocks – is up around 7% on the year, including dividends, which beats both inflation and the wider market.

So what lies ahead for 2012? And what should you be buying now?

2011’s biggest events were predictable – but the market reaction wasn’t

The world was hit by plenty of surprises this year. The Arab Spring series of revolutions wasn’t predicted by anyone as far as I know. And it was a bad year for natural disasters: from Japan to New Zealand to Thailand.

But the investment impact of these events was minimal. The big stories that hit markets this year were largely easy to see coming. It was the market’s reaction that might have taken you by surprise.

I think anyone with any sense knew the eurozone was going to end up in trouble. The optimists thought the European Central Bank would just print money, Bank of England-style, to bail everyone out. The pessimists thought Greece would leave Europe, or that Italy and Spain would go bust, sealing the currency’s fate.

Neither has been proved right – yet. As a result, the euro has remained surprisingly strong this year, down around 2% on the dollar, compared to where it started 2011.

The optimists didn’t grasp the extent of German opposition to money printing. That opposition may wane this year. The European Central Bank (ECB) is now run by a very pragmatic Italian, Mario Draghi. He talks like a German but is already doing quantitative easing by the back door (that’s what the recent programme of three-year lending is all about).

However, while this euro-QE might have saved the zone if it had happened a year ago, markets are harder to convince now. And there’s the constant risk of an anti-Europe party being elected in one of the member states. So while the pessimists were wrong about Europe breaking up this year, there’s no guarantee we won’t see something happen next year.

It’s a tough call. For now, I suspect that opposition to money printing will eventually be overcome, particularly as recession spreads through the region, even if it’s just a half-hearted effort.

Whatever happens, the euro is almost certain to end next year weaker than it is now. Money-printing would cause it to fall. But the alternative option – a ‘disorderly collapse’ – would prompt a rush for the dollar, and weaken it anyway.

As for stocks: there may be some gems amid the European rubble just now. James Ferguson tips a promisingly cheap French stock in the latest issue of MoneyWeek magazine. And we’ll be taking a closer look at what other bargains might be around in the New Year.

But if you want to play it safe, I’d stick with the same high quality defensives we’ve been tipping all year: if Europe does better than expected, they’ll benefit; if it collapses, they’ll be better placed to withstand the fallout than anyone else.

What about the US?

S&P’s downgrading of the US, which finally lost its AAA credit rating this year, was probably long overdue. But if you’d told anyone (including me) at the start of 2011 that the US would be downgraded, and that US Treasuries would still be among the best-performing asset classes of the year, you’d have been laughed out of the room.

So what next? It’s election year in the States, which means plenty of room for political upsets and surprises (here’s hoping Ron Paul gets a chance to shake things up a bit).

But overall, the US is looking increasingly like the best bet of a bad bunch for next year. Its banking system is healthier than that of the UK or Europe. It is less exposed to a European collapse than either China or Britain.

The US has also suffered a tougher downturn. While we’re still sitting on a paralysed, dysfunctional housing market, just waiting for it to topple, the US has seen a massive housing bust. On any sensible measure, property in the US is cheap. That’s not to say that it can’t get cheaper, but aside from the various mortgage-related legal disputes going through the US courts right now, it’s hard to see any more nasty surprises coming from that direction.

And further along the line, the country is making quiet, but steady progress towards increasing its levels of energy independence. Both shale gas and shale oil could be real geopolitical game-changers.

In short, if you don’t already have some exposure to the US – and the dollar in particular – I think you should get some. UK stocks with dollar revenues are fine. Big US blue chips like Microsoft are good too.

Emerging markets look vulnerable

With China’s bubble bursting, emerging markets look vulnerable to further falls. As I mentioned yesterday, commodities may also have a tough year. Falling commodity prices of course, could be more good news for developed economies – a lower oil price would certainly ease the squeeze on the consumer. But with upheaval in the Middle East looking certain to continue, predicting what will happen to oil over the next year is probably the toughest call of all.

Of all the emerging economies, the one we’ll be keeping the closest eye on is India. It’s less exposed to external problems, so if it could sort out some of its internal issues, it might be very well placed to make a comeback. That’s a big ‘if’ though – it’s one to watch for now (for more on the country, see my colleague Cris Sholto Heaton’s recent MoneyWeek Asia piece on India).

And read the latest issue of MoneyWeek to get our experts’ views on the other areas you should be investing in for the year ahead – they have some particularly interesting things to say about Japan. If you’re not already a subscriber, go on and treat yourself to an early Christmas present – by it now and you get your first three issues free.

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  • IJ

    This all sounds very sensible, but could that be the problem? Every market commentator is advising staying away from Europe and buying the US. Isn’t there a pretty strong case for doing the opposite, not just because it’s a contrarian view? First of all, European multinationals offer better value, higher dividends, etc. Sure, the risks in Europe are undeniably large, but at least they are at the front of investors’ minds. The US carries plenty of risks that are less in the open, therefore more dangerous. The US, unlike say “basket case” Spain, hasn’t even started making its fiscal adjustment yet; markets could force it do so sooner than we think. Profit margins in the US don’t look sustainable, particularly in an environment of fiscal retrenchment. US blue chip companies have been downgrading guidance, something markets seem to be ignoring as punters chase momentum into year-end. Finally, won’t the long dollar / short Euro call hurt US equities and favour European multinationals?


    I have never in my life met a pragmatic Italian – and I had to live in northern Italy for about a year!

  • Segedunum

    Not sure I can go along with that. It’s Europe today, but the US has all the problems that Europe has magnified many times. There is no escape. The dollar is going to collapse like a pack of cards because the only way they can get themselves out of the hole is to devalue the dollar.

    Seriously, if Ron Paul does not become president (and various interests will make sure that someone who knows what he is talking about doesn’t) the US is finished.

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