Has the gloom finally lifted in the markets?

The start of this year was no different to the last, with markets rallying following an increase in investor appetite and fund managers having high levels of cash holdings.

Although I see this as part of continuing volatility that the market has seen since the onset of the crisis in 2008, some of the extreme gloominess seen at the back-end of 2011 has started to unwind. Nonetheless, investors need to remain nimble when it comes to implementing investment decisions.

While investor appetite has changed slightly, the eurozone debt problem remains the greatest influence on the global economy and it appears that measures to address and resolve this are slowly being introduced.

The most important has been the European Central Bank’s (ECB) Long Term Refinancing Operation (LTRO) programme that has provided substantial liquidity to the European banking system.

All eyes are currently fixed on 20 March, when Greece has to find €14 billion to service its debts; this should not be seen as the end of the problem but one part of a wider solution that will necessarily take many years.

The key to addressing the overall crisis will be to create an environment that stimulates growth while at the same time continuing to cut government expenditure. Doing just one of the above will not be sufficient.

As uncertainty in the market continues, investors understand that they need to take more risk than they did in the past to receive income, and demand for income bearing assets will continue.

Within fixed income assets, investment grade, high yield and mortgage-backed securities offer the potential to reap good returns while government bonds appear to be relatively expensive; although against a backdrop of moderate growth, low inflation, risk aversion, weak private demand and central bank purchasing for the foreseeable future, sovereign yields are not expected to rise too much in the short term.

Last year’s investment returns were driven primarily by asset allocation rather than stock picking due to high correlation between different stocks and markets, as the markets lurched from ‘risk on’ to ‘risk off’ situations. This year we are seeing a shift towards a more favourable stock picking environment as markets become less correlated.

Equities are generally viewed as fair value and there seems to be a preference for Asian and US equities. Technology is also a favoured sector, and investors’ attention on the sector is expected to continue following Facebook’s decision for an initial public offering.

Debate around whether 2012 is the year for emerging markets will continue, although the underlying fundamentals will probably look more attractive in the second half of the year.

By Caspar Rock, chief investment officer at Architas