ETF Trends
ETF Trends

Despite another episode of intense but fleeting euphoria earlier in the year, at mid-year the global economy is in roughly the same position as it was six months ago—an anemic recovery threatened by a European crisis. Coming into 2012, our view was that there was an approximately two-thirds probability that the global economy would continue to expand, albeit at a below-trend pace, and a one-third probability that Europe would be the catalyst for another crisis. As of early June, we would stick with those odds.

Investors can take some comfort in the fact that the United States is on marginally firmer footing and that emerging market growth should begin to stabilize in the second half of the year as the impact of 2011’s monetary tightening wanes. That said, a number of risks have the potential to cause a global double-dip recession:

1.  Europe remains the major risk. While it appears that a Greek exit is not as imminent as some had feared back in May, the election results do not change the underlying fundamentals. Even if Greece remains in the euro, a bolder plan for tighter fiscal integration is proving frustratingly elusive.

2.  The need to recapitalize the Spanish banking system. This is now probably a bigger threat to the European enterprise than whether or not Greece decides to remain in the euro.

3.  The potential “fiscal cliff” facing the United States in six months, which investors may be underestimating. Not surprisingly, there has been no progress to date on addressing either the long-term fiscal imbalances or the massive, pending fiscal drag facing the United States in January. Given the soft recovery, if current policy is not altered, the risk of a US double-dip recession rises. As of this writing, while the subject is much debated, investor behavior suggests that this risk is not currently discounted into asset prices.

In light of these realities, we believe investors are in for a rocky road and volatility will remain elevated. We would still continue to advocate for a relatively conservative portfolio composed of high-dividend paying stocks—including in emerging markets—and US spread products, such as investment grade and municipal bonds.

Download the full commentary at iShares.com (PDF).