Sleepless nights over eurozone, China to extend into new year

Pension fund, endowment and money management executives cited the eurozone crisis, China and the fiscal cliff among the top issues that occupied their minds in 2012, some of which continue to vex them as we enter the new year.

Despite a stronger-than-expected performance by the Standard & Poor's 500 in 2012 and European Central Bank President Mario Draghi's commitment to buying short-term debt of European countries to suppress yields, a certain level of pessimism still exists.

“I can tell you that the things that have kept me up at night in 2012 sure feel like they're going to carry into 2013,” said Gibson Smith, Denver-based co-chief investment officer of fixed income at Janus Capital Group.

“The absolute levels on (fixed-income) yields do not make rational sense,” said Mr. Smith. “Obviously that's driven by these unconventional (government) policies. The markets have given all central banks around the globe kind of a pass: "We believe in what you're doing.' As we continue to see the effects of this policy and we don't see acceleration in economic growth, the markets could lose faith and credibility.”

Despite what appears to be overall pessimism by executives in the industry, not everyone has insomnia.

“Actually I've been sleeping pretty well,” said Peter Gilbert, chief investment officer at the $1 billion Lehigh University endowment, Bethlehem, Pa. “We started this investment office five years ago and I finally feel after going through the Great Recession that we've finally got our portfolio built out.”

“My view is we'll muddle through,” said Mr. Gilbert. “You know that (President Barack) Obama wants to leave a legacy and that doesn't include a recession, and the House of Representatives has to run every two years and they don't want to risk a recession, either.”

Still, the pessimistic outlook abounds. “Europe appears to have come back from the brink, but the underlying weaknesses are really pretty intense and time is what's going to make that worse and worse,” said Michael Brakebill, chief investment officer of the $34.8 billion Tennessee Consolidated Retirement System, Nashville.

“If you look into 2012, we really started on a low base. Right now we're kind of accelerating into the year at kind of a high base, which gives you pause.”

Lehigh University's Mr. Gilbert said: “Europe, I think, was a major concern for a while. It seems that, you know, the political will there is really strong to keep the euro together. Whether that's economically viable it's probably years out (before we know for sure). They'll keep kicking the can down the road.”

Much of executives' attention has been focused not only on Europe, but also overseas generally.

“We probably, on a macro level, spent time thinking ... (about) the fate of the euro and a (potential) Chinese hard landing. Third to that I'd add keep monitoring what was going on in Japan and (whether) that country would continue in its deflationary spiral as the year progresses,” said Ron Schmitz, chief investment officer of the $53.9 billion Virginia Retirement System, Richmond. “It just seems to me — and I really think I can say this objectively — the current crisis makes you feel pessimistic but it does seem to be more uncertainties and more headwinds in the global economy, particularly developed markets, than there have ever been.”

And there also are issues closer to home. Alan van Noord, chief investment officer of the $49.8 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, said pension funding, not only in his state but throughout the country, is one of his primary concerns.

“(At) PSERS and many other state funds, we have to talk a little about a funding issue ... State revenues are not increasing as fast as expenses, and general pension expenses are increasing at a pretty rapid rate,” Mr. van Noord said.

Mr. Brakebill agreed the economy continues to be a long-term concern.

“I think we're always concerned about making sure and hoping the economy and markets deliver what we need. On an economy and markets front, one of my concerns is we've all talked about fiscal cliff ad nauseam and that really is a trivial event for the most part ... the underlying economy's weakness is real and the underlying drag is real,” he said.

Dan Farley, Boston-based senior managing director and chief investment officer for investment solutions at State Street Global Advisors, said that despite overall concern about the economy, investors have ceased taking flights to safety.

“I think for me what's been very interesting as we've gone through 2012 ... has been the shift of investors back to asset classes and investment vehicles that caused them so much concern two or three years ago,” said Mr. Farley.

“In (the) asset-backed space, the flows into things like subprime have increased quite significantly as people have been reaching for yield,” Mr. Farley said. “Another one that is somewhat related has been the overall low level of volatility in the marketplace, and typically from our perspective, low volatility has been a sign of a period where investors have risk aversion.”

Erik Ristuben, Seattle-based chief investment strategist at Russell Investments, is encouraged that two-thirds of the world economy is in better shape now than at the beginning of 2012. “Europe did its best; I think if you look at the three big stories of 2012 we might as well get used to this cycle. The three big stories all have to do with macro issues, economic and policy issues, and interaction of economy and policy. Europe has to be at the top of the list,” said Mr. Ristuben.

“Looking at China — and by extension the rest of the emerging markets — it's a third of the world's economic activity, they were in a tightening cycle at the beginning of the year and the question was are they tightening too much?”

Going into 2013, Mr. van Noord said there are some positives.

“Housing pricing is up, starts are up, household formations are going up,” said Mr. van Noord. Although prices are quite low, “one of the concerns (is) we'll probably see a little bit more of the kind of flip side, the beginning of inflationary pressures toward the end of the year due to all the global monetary easing.” n