The crystal ball is particularly cloudy this year as I look back on my 2011 forecasts with a few cringes. The market’s job is to confuse the greatest amount of investors, but this year’s volatile, trendless market shredded many a confident prediction. Misery loves company, as they say.
But that was last year, and it’s time to boldly press forward and look ahead to what 2012 may hold in store for markets and the ETF business, which represents about $1 trillion in assets under management.
We know what worked in 2011 – ETFs tracking U.S. Treasuries, Brent oil and conservative, dividend-paying sectors such as utilities and consumer staples. [Treasury ETFs Lead 2011]
Conversely, funds indexed to alternative energy, natural gas and emerging markets such absorbed the biggest losses. The contrarian in me likes these sectors as turnaround plays.
Yet without further ado, here are my five main themes to watch in 2012:
- Currency wars and ETFs: Currency ETFs saw activity pick up in 2011 as more investors discovered the products to hedge risk and trade currency fluctuations. For example, traders are increasingly using ETFs pegged to the euro and the U.S. dollar to express a view on the Eurozone debt crisis. Meanwhile, some investors are turning to currency ETFs to hedge risks associated with a weaker dollar amid worries over further Federal Reserve easing, devaluation and the U.S. debt load and deficit. Not many advisors and investors have a portfolio allocation dedicated to currencies, but currencies are becoming a new asset class for individuals.
- Emerging markets over developed: Along with many others, I have egg on my face after predicting emerging markets would outperform in 2011. But I still like emerging markets for fundamental reasons. Valuations have obviously come down, and the real challenge is whether emerging markets can maintain economic growth rates in the high single digits. If the Eurozone debt crisis boils over and (God forbid) the U.S. goes into recession, then all bets are off, obviously. However, if the GDP numbers can weather Europe’s debt challenges and the U.S. can muddle through, I expect emerging markets to beat developed in 2012. Emerging markets rely heavily on exports, but they’re also seeing encouraging domestic growth and a rising middle class. They also have cleaner balance sheets than their developed counterparts that are saddled with massive debts.
- Are you prepared for higher interest rates?: With most investors having less appetite for risk and a desire for yield, expect more money to flow into bond ETFs in 2012 after they cleaned up in 2011. But looking at U.S. Treasuries, they’re offering very little return from a yield standpoint. The 10-year note is yielding 1.9%! No matter, apparently, as investors want safety from the European debt conflagration. I like corporate debt ETFs and emerging market bonds (with their diversification benefits) more than Treasuries. Despite paltry yields, investors feel secure in Treasury bonds because the Federal Reserve says it’s on hold on interest-rate hikes until 2013 at least. But what if the bond vigilantes turn their sights on the U.S.? Many including myself were early in calling for rising interest rates in 2011. Treasury yields are already down to historic lows, and the U.S. economy has shown signs of life recently. With so many investors piling into Treasuries and bond ETFs, a rising yield environment would be devastating. How many investors and advisors are ready and prepared for higher yields?
- Commodities and a flagging dollar: Commodities and gold ETFs have now firmly established themselves as an asset class that most advisors and self-directed investors firmly recognize. Gold is hands-down the champion, especially SPDR Gold Shares (NYSEArca: GLD - News) with over $60 billion in assets. Many of the ETF’s largest shareholders are hedge funds. Yes, the Dollar Index has rallied above 80, but the long-term trend in the greenback remains down, and remains up in gold. Right now, everyone seems terrified of deflation. But if the global economy recovers, we could shift back to inflation concerns and currency-debasement fears, which would bode well for gold.
- Gold miner ETFs will close performance gap with bullion: This is one that burned a lot of smart hedge fund managers in 2011 with miner shares seriously lagging bullion prices. The divergence between miner stocks and gold is very wide at this point by historical standards. Eventually, miners will have their time in the sun after all this underperformance. Miners have actually been very conservative in their profit outlooks and gold forecasts. I’m with David Einhorn in thinking that there is a major disconnect between miners and gold prices. If miners start to exceed earnings expectations, then hard-hit ETFs such as Market Vectors Gold Miners (NYSEArca: GDX - News) and Market Vectors Junior Gold Miners ETF (NYSEArca: GDXJ - News) will be ready for a sharp move higher.
SPDR Gold Shares
Full disclosure: Tom Lydon’s clients own GLD.