European Confidence is Critical

Terry Flanagan

The confidence of European investors in the coming months will dictate how the rest of 2012 will pan out.

“A loss of confidence in Europe will almost guarantee a recession in the region in 2012,” said Ethan Harris head of North America Economics at Bank of America Merrill Lynch. “We may even see a mild global recession if it continues to get worse.”

Although it remains too early to tell where the markets are headed, the first few months of 2012 will give an indication.

“This spring, we will get an idea of where we’re going for the rest of the year,” said Harris. “There will need to be fiscal discipline in Europe.”

As the ongoing debt crisis in Europe continues to weigh down investor confidence, amid a backdrop of a still-struggling U.S. economy, BofAML warns investors that volatile times lay ahead. The bank also says that political uncertainty, high oil prices, slowing growth and low interest rates will continue to weigh down investor confidence and stifle investment returns.

Despite the grim forecast, BofAML asserts that the potential for growth is there. Global equities could rally by 10% next year from current levels, aided by liquidity, modest earnings growth and cheap valuations.

Volatility has been on a wild ride in 2011, as the CBOE Volatility Index has shown. Two and three percent intraday swings have become the norm. The surges have come in the wake of a slew of macroeconomic events, including the European debt crisis, the U.S. debt downgrade, and the collapse of MF Global. The VIX reached a high of 48 on Aug. 8, as the markets reacted to the lengthy U.S. debt ceiling negotiations and the Standard & Poor’s downgrade of U.S. debt. It then fluctuated from the low-30s to the mid-40s in the following months, surging as European debt concerns weighed on investors and declining as hopes for a potential resolution surfaced. In late October, the VIX had declined to as low as 25. As of mid-day Jan. 5, the VIX was trading at about 22.

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