“Denial ain’t just a river in Egypt” – Mark Twain
Looking for bright spots in the global economy is a difficult task at present. There is no sense in trying to sugarcoat the truth: the undesirable “Ds” of Debt, Deflation and Default (Denial could be a fourth) in Europe and around the world are significant drags on prospects for growth. Investor confidence is low and the probability of financial accident is not immaterial.
Where do investors go to hide in this environment?
- Cash is not a long-term solution. Cash and short-term investments will protect you from any short-term volatility, but the consequence is a slow erosion of purchasing power, with inflation running at a higher level than available yields.
- Bonds are becoming ever more risky. Fixed income securities had another splendid year in 2011 with returns approaching double-digits, but with long-term yields near historic lows, the New Year promises to be a challenging one. Generally, deflationary trends in world fiscal policies and macroeconomic uncertainties could continue to support bond prices – but what is usually considered a conservative asset class is becoming ever more indeterminate.
- Hedge Funds have not lived up to their promise of low volatility and absolute returns. According to Hedge Fund Research, a leading tracker of hedge fund performance, equity-focused hedge funds returned -8.0% on average last year in U.S. dollars for their second significant loss in four years (in 2008 the average loss was -26.7%).(1) The over-proliferation of this asset class is making it increasingly difficult to find hedge funds that are able to consistently achieve their intended objectives.
- Cyclical stocks are unlikely to rebound. Companies whose profits tend to ebb and flow with the business cycle had a difficult time in 2011. With rapid economic recovery a low probability for 2012, the potential reward for having a high weighting to cyclicals in your portfolio may not warrant the risk.
- We believe that a continued focus on undervalued, high-quality global multinationals will remain the place to be for investors in 2012.
Despite the possibility of negative outcomes from public policy mistakes in the U.S. and Europe, as well as the potential for a slowdown in China, we are generally constructive on the equity markets going into 2012. We suspect the world economy will continue to muddle through, led by a slow recovery in the U.S. At Burgundy, we strive to take little financial risk through the balance sheets of our companies, and since valuations are currently reasonable, we believe they are offering solid margins of safety. While there are political and economic risks in abundance, the companies in which we invest have shown an ability to deal effectively with those perils over the past four years.