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So far…so good

After a tough time in 2011, things appear to have turned sweet for financial markets in the current year. The New Year celebrations seem to have gotten extended by quite some margin in 2012 with the conventional burst of euphoria that surrounds January 1st not relenting even as the Chinese New Year approaches- ensuring a period of impressive scaling up for the risky assets and its no surprise to guess that the winners have been emerging markets and gold. The newsflow on the economic front has been rather mixed with the backward looking data coming in mostly upbeat even as broad worries remained on the near term economic outlook for the entire global economy.

While US consumer sentiment hit a seven-month high in January and German economic confidence improved at the sharpest pace on record in January, the worries pertaining to debt strapped Eurozone economies  and moderating emerging markets continued to hover on the broad macro picture. The world bank was acutely grim of its assessment of the current year, saying that world economy in 2012 is set to grow by just 2.5 percent, weighed down by ripple effects from the 2008 financial crisis. The bank further noted in its latest Global Economic Prospects (GEP) 2012 report that the sovereign debt crisis in Europe, which took a turn for the worse in August 2011, coincides with slowing growth in several major developing countries (Brazil, India and, to a lesser extent, Russia, South Africa and Turkey), mainly reflecting policy tightening begun in late 2010 and early 2011 to combat rising inflationary pressures from overly-fast growth. As a result, developing country growth for 2012 is now forecast at 5.4 percent, the second lowest over the past 10 years. The Bank has also lowered its growth forecast for high-income countries in 2012 to 1.4 percent and -0.3 percent for the high-income Euro Area.

This is interesting stuff. The bank is very right in saying that major emerging economies appeared to slow down just as the Eurozone debt rumble rammed into top gear.  China’s latest GDP growth of 8.9% was the slowest in two and half years for the world's second-largest economy. While the country seems to be on a right track as growth is easing well in line with the policymakers who scrambled to rein in runaway asset prices last year, an imminent cooling off may not be good news for world economy. While keeping demand for commodities depressed, there is possibility that the PBOC would revert back to its rather mean game of keeping the Yuan depressed and artificially keeping the export prices low.  China’s plentiful reservoir of foreign exchange and the fact that the country is slated to undergo deep leadership changes in the current year would ensure that growth agenda would be kept intact- come what may in Europe or anywhere else. This should keep the central bank in the country busy- ensuring a rather expedited effort to open its monetary taps.

Europe has plunged into a fresh crisis after France admitted it had been stripped of its coveted AAA rating in a mass downgrade of at least half a dozen euro zone countries by the credit ratings agency Standard & Poor's. The Euro plummeted to a 17-month low against the dollar and the European Central Bank was forced to step in to buy Italian bonds after European sources admitted action by the ratings agencies was imminent.

However, despite of this, the gains in equities did not evaporate. Most of the emerging market equities witnessed good buying from foreign institutional investors- just in line with the conventional pattern, which is associated with the risky assets. Given the macro headwinds, is it fair to read too much into the good performance of the emerging market equities? May be not. Capital flows to developing countries had weakened sharply in second half of last year as investors withdrew substantial sums from developing-country markets. Gross capital flows to developing countries plunged to $170 billion, only 55% of the $309 billion received during the same period in 2010, according to World Bank data. Developing-country stock markets lost 8.5 percent of their value since July-end till December end. This, combined with the 4.2 percent drop in high-income stock-market valuations, has translated into $6.5 trillion, or 9.5 percent of global GDP, in wealth losses for the equity markets.

It is understandable that investors are latching up into the downtrodden stocks at the current valuations then. However, it will be interesting to see how equity investors play in 2012.  While its still very early days in the New Year, its likely to be a rather mixed year-something similar to 2011 with the only exception being that emerging market equities might not witness the kind of drubbing seen in last year. Investors were exceptionally cautious in 2011- entering into a new decade after enduring two painful bear markets in the earlier one and not many reasons abound as to why the sentiments would change radically in 2012- already been dubbed the year of doom!

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