Some Thoughts on 2013

Relative to 2012, the stock markets enter 2013 facing a period of relative geopolitical calm.  The US presidential election has passed, China had a peaceful power transition and Super Mario appears to have saved the eurozone (at least for now).  Nevertheless, that calm will be relative, as we enter February with the one two punch of the US Debt Ceiling and the Italian elections.  In the US, we will have more grandstanding and brinksmanship, but some sort of deal should be worked out as it has before.  In Italy, while current technocrat Prime Minister Mario Monti and his center left allies are favored, the always interesting Silvio Berlusconi is running again.  Given the political structure, Italy could once again become ungovernable after the election.  This would return turmoil to the third largest economy in the Eurozone.

Source: JPMorgan Funds

These two events bring to mind that while the developed markets in general may be cheap relative to their own histories and some even to the rest of the world; many face a daunting list of obstacles that limit those valuations. 



The US and much of Europe face the future needing to confront the aftereffects of the housing bubbles, the banking crisis and the sovereign debt crisis.  This is complicated by their aging demographics, debt burdens (with or without entitlements) and increasing regulatory burden.  Combined these factors describe the conditions of a secular bear market.  Until some/most of these issues begin to get resolved, the P/E expansion of these markets would appear to be limited.  As a reminder, prior secular bears have lasted anywhere from twelve to eighteen years. 



Source: JPMorgan Funds

An interesting exception to this general developing market malaise may be Japan.  While generally unnoticed, there were some potentially major changes in Japan last year.   These included the setting of an explicit inflation target by the Bank of Japan and the return of the LDP to power.  Since the election, the yen has dropped sharply in value against the dollar (See chart below of Yen/dollar exchange rate for the last year).  This has been a boost for Japanese exporters.  In addition, the new government is expected to announce a large fiscal ($136bn or 2.5% of GDP) stimulus package to help kickstart growth.  Combined with low valuations and expectations, this could be very interesting.  While only time will tell if this is the start of Japan finally leaving its lost decades, or simply another failed attempt to do so, Japan is definitely one market to watch in 2013.  



Source: Wall Street Journal

The emerging markets are a different story.  In general, they have favorable demographics, solid finances and a strong backing for deregulation and growth.  These are conditions for a secular bull markets.  While some are no longer cheap relative to the rest of the world or their own history, many still are and offer plenty of opportunity. 

 Source: JPMorgan Funds