The 3 Ls of 2013: low growth, low returns, lower risk

December 21, 2012

Dec 20 (Reuters) – Look to 2013 to be the year of three
Ls: Low growth, low returns, and thankfully, lower risk.

The upshot for investors may be a calmer year, but possibly
one that is less lucrative. It could be quite a contrast from
2012, which featured plenty of drama, notably in the euro zone,
but also decent returns courtesy of a 12.5 percent gain in the
S&P500 stock index and a similar return from global shares.

Extraordinary monetary easing and pledges from the Federal
Reserve, the Bank of Japan, and the European Central Bank will
provide a safety net to investors in 2013. However, we still
face a global economy that is facing both deleveraging and a
drag from falling government spending in important economies.

What’s more, the juice that fueled the stockmarket gains
this year – relief from central banks that pushed money into
markets and averted a euro zone blowup – is a one-time gain. In
2013, investment gains will have to come from economic growth,
which will be scarce, or an increase in what investors are
willing to pay for that growth.

All of that adds up to the prospect of a less fraught year,
but not, crucially, a more profitable one.


Even with massive monetary policy support, it is tough to
get much growth when large swaths of the globe, such as the euro
zone and Japan, are in recession. Others, notably the United
States, face a headwind from decreasing government spending. It
is impossible to know how the “fiscal cliff” drama plays out,
but almost every scenario ends with consumers and companies
seeing less money flow into their cash registers and pockets.

Barclays estimates that 2013 will bring an aggregate 1.1
percentage points of growth cut from gross domestic product in
industrialized countries due to dwindling public spending and a
1.5 percentage point cut in the United States.

On top of that, the euro zone will still face massive
balance sheet issues, as banks, households and governments try
to reduce debt at the same time. That has, and will, generate a
powerful deflationary force. The bottom line is GDP growth of
0.5 percent to 1.0 percent in the United States and 5.0 percent
to 6.0 percent in emerging markets next year.


Financial market returns will come, essentially, from one of
two places: economic growth or more willingness to pay for
growth. Neither side of the equation looks particularly
promising in 2013.

If overall U.S. economic growth is low, stocks could rally
if earnings outpace the economy, but given that corporate
earnings as a share of GDP are at record highs, this is hard to

The other hope is an increase in investor demand for
earnings, assets and yield, although investor appetite may wane
compared with 2012. Sovereign debt is very expensive on most
measures, often paying a negative real return, while corporate
debt is, on some benchmarks, as pricey, and risky as it was
before the crash.

Virtually all of this year’s gains in global stocks can be
explained by an expansion in the multiple of earnings investors
were prepared to pay. According to Morgan Stanley, developed
world equities were trading at about 9.5 times expected forward
earnings last October, but they now fetch 12.5 times.

One area that could drive equity returns are asset
allocation flows if investors begin to reverse their march out
of equity and into debt. That could provide powerful multi-year
support to equities, but would come with danger. If it happens
too quickly, if interest rates rise too rapidly as debt sells
off, equities will have a hard time, too. If bonds sell off, a
lot of people will lose a lot of money.


The big plus for 2013 is the expectation that central banks
will do what is needed to stave off disaster, and that they will
act as the re-insurers of last resort against the worst

The stance of the ECB, for example, which effectively
underwrote the survival of the euro project over the summer of
2012, is much different from a year ago. While it is hard to
know if this is good or bad long-term policy, it is definitely
market friendly short-term policy.

Similarly, the U.S. Federal Reserve, if anything, increased
its commitments, tying its policy more explicitly to
unemployment and signaling it will tolerate a bit more inflation
to help jobless rolls shrink.

The likely outcome: investors may sleep better but are
unlikely to make as much of a return.

“Investors are improperly extrapolating the total returns of
2012 into 2013,” wrote Greg Peters, Gerard Minick and Jason
Draho, global strategists at Morgan Stanley, in a note to
clients. “Given that returns were largely valuation gains, it is
important to remember the catalyst of policymakers’ removal of
tail risk, a benefit that occurs only once.”

The best outcome for which we can hope is that 2014 brings a
cyclical recovery and a clear path to debt reduction. That would
make it the first ‘normal’ year in at least eight.

The worst case boils down to this: investors lose faith in
central banks and the money those institutions create.

(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns

(James Saft)

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