5 Investment Scenarios for 2013

• Age of Separatism (35%): The US economy leads the developed world. Emerging economies—and assets—outperform. Europe recovers at a snail’s pace while China’s economy re-accelerates.
  
• Stop 'N Go (30%): Sluggish global economic growth, with false dawns in the US and emerging economies. A European recession and tight credit for those who need it. Deleveraging keeps a lid on growth and risk taking.
  
• Go Growth (20%): Key economies such as the United States, China and Europe grow faster than expected. The global economy starts weaning itself off monetary stimulus.
  
• Nemesis Redux (10%): A global recession, credit crunch, social upheaval and steep losses across asset classes. Named after the Greek goddess who punishes the proud. 
• Inflate Away (5%): High commodity prices and monetary easing drive up inflation around the world, effectively cutting the developed world's debt load.
  
  

35%

Description: The US economy leads the developed world. Emerging economies—and assets—outperform. Europe recovers at a snail’s pace while China’s economy re-accelerates.
 

Our Probability: This is a renewed version of our previous Divergence scenario. We renamed it to emphasize its long-term nature—and the US economy’s potential to be a global growth locomotive.

Preferred Assets: Relative value investing and (emerging market) equities are favorites. Emerging market debt also is attractive.
 

Signposts for Change: Correlations between asset classes decline further. Relative strength of monetary and fiscal policies by individual countries. Washington avoids the “fiscal cliff” and outlines a credible budget deal.

30%

Description: Sluggish global economic growth, with false dawns in the US and emerging economies. A European recession and tight credit for those who need it. Deleveraging keeps a lid on growth and risk taking.

Our Probability: This is our previous Stagnation scenario. It has become the market consensus. We still give it pretty high odds. The crowd could be right.

Preferred Assets: Risk-on/risk-off rallies dominate trading. This means super short-term and super long-term strategies. The hunt for yield favors dividend stocks, emerging market debt, high yield and US commercial mortgage securities and municipal bonds.

Signposts for Change: Scattershot growth trends and flat money multipliers.Haphazard policy moves to stimulate growth and achieve sustainable debt levels. The United States agrees on a Band-Aid budget deal.

20%

Description: Key economies such as the United States, China and Europe grow faster than expected. The global economy starts weaning itself off monetary stimulus.  

Probability: Did we take happy pills? Maybe -- but the probability of pleasant growth surprises has risen, partly because the bar is pretty low. And a lot of things can go right, too.

Preferred Assets: Gear up for a massive risk-on rally, with investor monies parked in cash, fixed income and quality stocks flowing to emerging market stocks and discounted European and Japanese equities.

Signposts for Change: Growth in credit creation and bank lending. Sell-offs in short-dated instruments such as bills and commercial paper. A grand US budget bargain that puts its fiscal house in order and stimulates growth. China, Brazil and India carry out growth-boosting structural reforms.

10%

Description: A global recession, credit crunch, social upheaval and steep losses across asset classes. Named after the Greek goddess who punishes the proud.

Our Probability: We see a smaller chance of Nemesis as risks of a eurozone breakup have receded and China’s economic momentum looks to be strengthening. US and Middle East leaders hold the keys to Pandora’s Box now.


Preferred Assets: The usual suspects of US Treasuries, German Bunds and the Japanese yen. Watch the danger in safety, though. Investment grade credit should do relatively well. Short-term volatility is low, so downside protection is cheap. Get it while you can.

Signposts for Change: * Populist policies of debt defaults and protectionism. Funding markets seize up again. Social unrest and unexpected geopolitical crises. Political dysfunction reigns in Washington: No budget deal and a nasty debt ceiling fight. A “Grexit” or massive deposit flight rekindles fears of a eurozone breakup.

5%

Description: High commodity prices and monetary easing drive up inflation around the world, effectively cutting the developed world's debt load.  

Our Probability: Okay, inflation is still far-fetched. Markets can turn on a dime if they get a whiff of it, though. Few investors are positioned for inflation, and it could be triggered by unexpected geopolitical events. Stay tuned.

Preferred Assets: Commodities and hard assets such as real estate tend to offer some protection. Sell stretched safe haven government bonds.  

Signposts for Change: Bubbly equity markets. Money velocity jumps. Inflation beyond food and energy. Washington kicks the can down the road by agreeing on a budget deal that eliminates all fiscal drag—and ignores the deficit.