The coming year promises to be one of transition – politically in the United States with the presidential election, financially in Europe with the potential breakup of the monetary union, and economically in China with slowing growth.
As I put together my annual look-ahead for clients, I felt certain about only one thing – that the global economy is going to endure a significant amount of debt "deleveraging" as we move through 2012.
The world will shed debt through some combination of default, write-downs, repayment and rising savings rates. This deleveraging will be accompanied by social unrest, political upheaval and the potential for some sort of shock to the banking system. And it will be cemented by a growing acceptance that spending beyond one's means isn't something that can go on forever.
The deleveraging shock ahead means that risks are higher than normal for this stage of the economic cycle. The performance of global bank stocks and the bond market in 2011 has been hauntingly similar to the pre-recession pattern in 2007.
If a recession is in store for 2012 – and the odds are still elevated – then the bear market in stocks and real estate is back on. Investors should remain focused on high-quality investments like strong, dividend-paying stocks and use volatility to their advantage by becoming ever more tactical and opportunistic.
The global economy is not going to be fixed overnight. Even if "Merkozy" and the rest of the European politicos figure out a plausible way out of the current debt crisis, they will have only bought themselves time. Even if the U.S. Congress does figure out a way to play nice and allow a measurable pulse to return to the economy, it won't be enough to offset the amount of debt still floating around in the world, especially in the United States.
Investors may finally learn this year to stop worrying about inflation. The real danger is deflation, as declining credit faces an expanding supply of goods and services.
The strong deflationary current will reshape social attitudes. As baby boomers face retirement, their focus will change from hoping for inflation in asset values to a concerted effort to adjust lifestyles to a more frugal template. They will spend more time on long walks and tending to the lawn, less time at the mall or on the golf course.
And how will that play out in 2012 from an investment standpoint? I will be watching for some indication that inflationary expectations have fallen so low that an end is in sight to the great bull market in bonds. Only when people no longer fear inflation will the three-decade bull market in bonds finally be over.
For now, that's still a way in the distance. My colleagues and I continue to gravitate toward corporate debt as well as income-generating and alternative strategies like hedge funds that produce attractive risk-adjusted returns.
Bonds remain attractive. With the default rate for high-yield corporate bonds running at just 1.94 per cent – and not budging this year despite stalling economic growth – junk bonds may, in some ways, be a better credit risk than U.S. government debt.
What I see in 2012 is a continuation of the same problems as in 2011, but with lots of opportunity in areas like bonds and premium equities.
And they call me a perma-bear.
David Rosenberg