| NEW YORK
NEW YORK Money managers are bracing for more market volatility and political uncertainty as they weigh their investment choices in 2012, reiterating a warning that simply holding cash won't completely insulate investors from losses.
The uncertainty stems from Europe's unresolved debt crisis, which faces a big test later this week in Brussels when European Union leaders meet to hash out an agreement on budget discipline, as well as major elections in nearly half of the Group of 20 nations in 2012.
Speaking at the Thomson Reuters' Lipper Investment Series 2012 Outlook panel discussion on Tuesday, the experts all anticipated weak economic growth in 2012.
"We'll continue to have two steps forward, one step back. People (are) looking at the severity of the teeth of any policy statement that comes out and viewing it very skeptically. What that means is markets will be volatile," said Christine Thompson, chief investment officer of Fidelity Investments bond group.
The fear factor has driven cash into U.S. Treasuries and pushed yields to historic lows, whereby the current rate of U.S. inflation, 3.5 percent, guarantees a negative return on the debt when compared to a 2.09 percent yield on benchmark 10-year U.S. government debt.
"That is something you have to factor in, but it will be a return of your money if not a return on your money," she said.
While this week's hot button issue is how to ensure Italy doesn't implode, the panel said the United States also needs to address its budget deficit, with some highlighting spending cuts alone would not resolve the problem.
In August Standard & Poor's cut its AAA rating on the United States in an unprecedented move, citing the political gridlock in Washington as a significant factor.
Last month, Moody's Investors Service warned the U.S. government not to skimp on deficit cuts after a special U.S. congressional committee failed to reach an agreement on deficit reduction.
The rating agency maintained its Aaa rating but any pullback from agreed automatic cuts to take effect starting in 2013 could prompt it to take action.
"... what has been significantly absent is the political will to get it done," said Lisa Shalett, chief investment officer at Merrill Lynch Wealth Management.
On Monday, S&P issued a similar warning to the euro zone nations, saying they too face a credit downgrade if they do not come up with a solution to meet their credit obligations.
However, a break-up of the euro zone and its currency was not expected.
"It easy to talk about the break-up of the euro, but when you talk about damage to the banking system and economies, I think it is just so horrendous that they'll do anything to stop that," said Robert Auwaerter, head of the fixed income group at Vanguard.
The near constant roiling of markets this year, be it stocks, currencies or credit has resulted in a massive flight from riskier assets to safer trades such as U.S. Treasuries, pushing those yields toward zero.
As a consequence, one of the few sectors where cash is flowing is into dividend paying stocks as a replacement for earnings lost out to low yielding debt.
According to Lipper's U.S. fund flows database, which tracks the movement of cash in over 21,000 funds, year-to-date the assets under management in the equity income category are up 26 percent to over $104 billion.
The question is whether that strategy is overdone?
"Probably for the first time in 5- years we are actually underweight higher dividend stocks because we think there is a little bit of a bubble in utilities, and telecoms, mid-cap consumer staples, where the market is putting much too high of a value in that dividend," said David Giroux, co-manager of T. Rowe Price's large-cap value strategy.
While dividend paying stocks might be richly priced, the lack of investment choices continues to drive cash into high yield bonds and emerging markets, albeit more selectively.
Municipal bonds are also an attractive area said Fidelity's Thompson and Vanguard's Auwaerter, despite the bankruptcy declared by Jefferson County, Alabama and Harrisburg, Pennsylvania's attempt, since rejected by a federal judge last month.
Don't count European assets out just yet, said Colin Moore, chief investment officer of Columbia Management Investment Advisors.
"If I was being speculative about 2012, I actually might buy European equities. there's a lot European corporate earnings which are doing quite good, which also affects their bonds. The risk premium is clearly extremely high and any mild solution there triggers off a big revaluation of the market," he said.
(Reporting By Daniel Bases, Jilian Mincer and Richard Leong; Editing by Kim Coghill)