2011 was a difficult year for the majority of stock market players, with contrasting performance across the globe. What seems to have passed us by is the relative success of the larger US companies, with the Dow Jones index finishes an amazing 6% higher on the year; compared to the UK’s FTSE 100 index falling 5.5 % and Italy’s FTSE MIB Index experiencing a painful 25.7% decline. During this downward journey for the European Stock Markets in particular, the price movements were violent, which resulted in even the most savvy of investors or day traders, licking their wounds. Certainly in the 25 years I have been trading I have never seem such a relentless pattern of markets looking so weak at one moment in time and then turning on a sixpence a second later to look like the best thing since sliced bread. These conditions favour few investment or trading strategies. Even if you lean towards range trading, you may have to see your position go significantly against you before a chance of profiting.
This extreme volatility has resulted in many institutional market-makers sitting on their hands, which in turn reduces the liquidity, which in turn increases volatility further.. and so on. The question on everybody’s mind right now is what will 2012 bring for the financial markets, global economies and the Eurozone.

Coming back to my point of the Eurozone crisis story being sidelined by other events in 2012; I almost feel that it will not make much difference, in the the long run, if some European countries break
rank and go on their own. This is not to say that instability and uncertainty won’t feature in the short term for countries who pull out (or get booted out) of Europe; however fiscal independence did work for the majority of these nations…for hundreds of years previous to adopting a single European currency. So a possible scenario is that the weaker, debt ridden Mediterranean countries may well leave the Eurozone one by one throughout 2012, but will gain strength from their independence eventually and thrive again. This would leave a stronger northern European Eurozone; possibly just consisting of the Benelux counties, Germany, and France; thus tempting the likes of the Scandinavian counties to join and even Britain ! Either way, the end result is not necessarily a bad one, giving an element of credence to those who look to profit from long term investments in European equity markets.

So what could divert our focus for the next 12 months ? Well where should i begin… continuing turmoil in the Arab states, a US presidential race with a potential for change of leadership in the four most powerful counties in the world; America, France, Russia and China… Then there’s the global economic outlook to consider; not just whether we are double dipping, but just how big the second dip will be..
Depending on the direction the economic outlook takes, this will no doubt directly impact interest rates. If the economy is rebounding (upwards) then this gives the green light for an increase in rates, taming any resurgence of inflation, but threatening the debt ridden consumer, who to date had ridden the recession with the bonus of lower mortgage payments.
Either scenario for the economic growth may well override the focus on Eurozone woes (although partly connected), coupled with threats of unrest in the middle east and uncertainty in South-East Asia.
With stock markets looking attractive for their rate of return, given the low interest rates available from the banks, there may well be opportunities to profit in 2012; but be warned, the unexpected often lies beneath, so prudence may be necessary to prevail the coming months..

Many supposed that Europe was simply too big to fall, and to a certain extent, they were right. However, that was always underpinned by the assumption that the larger northern European nations, namely France and Germany, teamed with the IMF, would just keep bailing out the weaker nations. This is all very well, until those nations or global monetary funds fall into difficulty themselves, thus turning to their own fiscal woes…after all, charity begins at home.

With Italy soon to be under new leadership, it may allow some breathing space to its current debt woes, but the problem has just not gone away. Things are not much better closer to home either. It was only two months ago when the Bank of England thought 2012 would yield 2.1% in economic growth, yet a few weeks later many forecasters are set nearer 1%; forcing the Bank to revisit its own forecasts this week.

Our professional client base is seeking to profit from the Eurozone fallout, mainly via the FX markets. The continuing weakness of the euro has finally brought some attention to the pound, which has until now been just an understudy to the US dollar. Although the UK is on the fringe of continental Europe and therefore directly affected as a result, it is surprising that the pound has not shown relative strength against the euro. The GBP/EUR pair has been predominantly trading in the 1.10 to 1.20 range for the last year, with momentary blips beyond. Recently, however, it has attracted interest from professional traders who have built long Sterling, short Euro positions, driving the GBP/EUR pair up to 1.17. This momentum may test the 1.20 level, a breach of which will have commentators talking 1.30 as the next stop. It is tempting to assume that interest in our currency is a good thing, but the impact of this is that exports become less attractive. This double edged sword is fine when economies are booming, but not so when it’s hard to make ends meet.

Although the bond markets are a tempting play for professional traders, their interest is normally reserved for changes in the interest rate cycle; however a change in the cycle, i.e. interest rates rising again, now seems a way off with ‘double dip’ taking centre stage again; so unless you are trading sovereign debt, which is definitely not a product for the risk averse investor, then primary focus remains on the currency markets.

Within our clients base trading outside the FX market, the consensus is that equity markets should be lower, but patience is required. As quiet markets tend to drift higher our professional clients tend to place stop loss limits a healthy distance away.

Gold has lost its shine, as far as interest amongst the professional traders is concerned, as the volatility has faded following the assumption that inflation may well be topping out.

In the midst of this turbulent economic storm we are at least granted one ray of sunshine. Eventually the Eurozone crisis will reach its peak, whether by organic default or never-ending intervention, at which point the global economy will build on it’s more solid but transparent foundations leading to a long period of growth and prosperity… not a matter of if, but just a matter of when…

The period running up to August was both calm and predictable. The markets found a comfortable range within which to trade and since April the FTSE stood at a constant 200-300 point range. Many, including myself, expected a quiet summer – albeit with a small print disclaimer, ‘Assuming no crisis rears its head’.

It turns out it was fortunate that disclaimer was in place. At the beginning of August a crisis hit when the United States lost their AAA credit rating for the first time in their history. This served as confirmation that the sovereign debt crisis was not just confined to the weakest members of the Eurozone, but also to the mighty US.

This was the catalyst for a sharp revaluing of the global equity markets, with most developed world indices corrected by over 10%. The following six weeks offered little respite, with the daily ranges enough to catch out even the most sophisticated traders. As we know professional traders thrive on volatility and the movement of the volatility index, the VIX, which shifted from 15 in July to 47 in mid-August, would suggest a bumper crop for the astute speculator. However this was far from the case.

When markets plummet and continue to feel weak, professional traders normally short the market, looking for a continuation of the move. However it was soon apparent that one minute the equity markets would look extremely weak and the next minute, and I mean ‘minute’, the markets would reverse and return a great deal stronger. These choppy conditions are not favoured by the professional traders and many struggled to capitalise on what would normally be an early Christmas present of volatility. These conditions were certainly not helped by the relative illiquidity of the summer markets, but they were accentuated by the underlying sense of uncertainty of what lay ahead.

However, commodity bulls were able to make the most of this unease with the price or Gold jumping to just shy of $1950/oz and many analysts suggested it could fly higher still to $2500/oz. These severe daily ranges that rocked the equity markets have subsided slightly, and this has seen gold priced down to $1600/ounce. The slight reduction in volatility is no bad thing for both the pro traders and the retail investors, who may decide that now is the time to re-enter the market, albeit in a more controlled fashion.

Nobody likes the Euro, especially the professional traders. While eyes had been firmly focused on the equity and commodity markets for most of the summer, the EUR/USD spot contract had been relatively neglected with limited activity, confined to a 1.40-1.47 range since May; however in September the 1.40 level was breached and the market has not looked back since, with lows of 1.3350 within a couple of weeks of the break. Any rally in this contract seems to be viewed an opportunity to short again. Work on the street is that 1.38 is a major resistance level and pro traders are likely to generate short positions there, although it appears that the shorting on the current up move has already begun…

With a Greek default seemingly imminent, the most volatile markets may yet materialise, generating opportunities where the risk rewards may be unpalatable to most traders, professionals and retail investors alike.