NEW YORK CITY-As the commercial real estate industry continues to operate under the cloud of the Euro zone crisis, panelists at Prudential Financial Inc.’s “Global Economic and Retirement Outlook” predicted that strong opportunities will exist in high-yield debt, CMBS and emerging markets in 2012. But given a weakened US economy, debt woes in Europe and increasing concerns of a property bubble in China, significant risks and uncertainty remain.
“We are looking at a world in 2012, in essence, of risky business,” said Quincy Krosby, chief market strategist at Prudential Annuities. “You will be punished if you are not in the equity market when the market feels like celebrating, but you will also be punished if you are not in fixed-income. It’s going to be a world in which you are going to want to have a firm footing in fixed income, but also spread out across the risk spectrum in equities.”
Edward F. Keon, managing director and portfolio manager of Quantitative Management Associates, said the burden of proof has shifted from stocks to bonds over the last decade. Based on fundamentals, however, Keon expects equity returns to remain in the high single digits and bonds will most likely will “pass the baton” to stocks.
“Stock prices are much more volatile than you would expect, due to changing fundamentals,” he said. “The question is if this year is likely to be a surprise on the upside or the downside. I’d say it would be more likely a surprise on the upside. All of the issues we are worried about are the things the market well knows and are probably embedded in stock prices.”
From a global perspective, John Praveen, managing director and chief investment strategist at Prudential International Investment Advisers, LLC, said while Europe remains a concern, other factors—like attractive valuations, low interest rates, rate cuts and liquidity measures—should help the stock market regain its footing.
“There has been a lot of movement, but it seems [Europe] hasn’t been able to come up with a game changer to solve the problem,” Praveen said. “They are going to continue to see this problem fester on during the year. The markets are going to test what the policymakers do to defend the Euro and to prevent sovereign default and banks from going under.”
Praveen said core economies—like Germany and France—are going to experience “very weak growth,” while periphery markets like Greece will see a deeper recession. “That is probably going to complicate a resolution of the debt crisis,” he said. “This will probably keep the markets under clouds.”
However, as corporations reign in their balance sheets, raise high cash balances and turn out debt, the US economy is poised for slow GDP growth and small, but positive gains in employment. Michael K. Lillard, managing director and chief investment officer at Prudential Fixed Income Management, also predicted that inflation will remain moderate.
“We predict that unemployment, which was pretty high at 8.6%, only declining slowly,” he said. “The other thing we see is a slow growth environment, which is 2.3% GDP growth in the United States. When you combine all those factors together, we institute a hold, but it has probably been on-hold longer than they’ve indicated so far. That is going to keep money market rates at zero for the foreseeable future.”
Lillard said to watch out for higher-quality, high-yield bonds, where spreads average around 450 basis points over treasuries. “That’s not only because of the strong fundamentals in the marketplace, but because we actually weeded out the weaker companies in 2008,” he said. “A lot of those companies defaulted at that time. What we are left with are stronger companies that have managed themselves in a very conservative way.”
Opportunities also exist in structured product markets, Lillard said. “In those markets, you can buy very high quality, triple-A rated CMBS,” he said. “These types of securities have actually performed very well. These spreads are 125 to 250 depending on which one you look at. At this point, you’ve got five years of loan experience and you can actually see the credit quality and the underwriting, and you have quite a bit of visibility.”
Overall, Krosby said the weakened Euro could help the US dollar gain traction. “The US equity market could do very well with a stronger dollar,” she said. “The relationship that we see today isn’t based on stronger US economic data per se, but based on the default of problems in Europe and then the US dollar gets stronger.”
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