If we had to sum up the current investment environment in one word, it would be “uncertainty.” World financial markets are currently extremely fragile as Europe heads towards recession, the United States faces the possibility of a “double dip” (or at least lethargic growth with persistently high unemployment) and China's growth potentially slows.

U.S. equities were flat, international equities fell double digits and Treasury yields tumbled to 2 percent. Even alternative asset classes, like hedge funds, usually positioned to do well in periods of volatility, struggled last year.

Few predicted the asset classes that delivered strong returns last year: lower risk assets like Treasuries (up 6 percent) and high quality municipal bonds (up 6 percent). Investors and those advising them should take away two important lessons from 2011:

1. Government actions are unpredictable and can meaningfully move the markets

   Last year saw a number of unanticipated governmental actions that negatively impacted financial markets worldwide. Primary among these was the recent U.S. debt crisis, in which hard line partisan politics forced an untimely stalemate on a pressing issue. Due to Congress' threat not to expand the debt ceiling (and thus, default on our debt payments), the U.S. credit rating was downgraded largely as a result of the lack of international confidence in our government's ability to function properly. Following a compromise during the summer, the Congressional “Super Committee” failed to come to an agreement and mandatory across-the-board spending cuts are now on tap for 2012.

   The issues weren't limited to the United States, however, as European governments also seem to have failed to instill confidence that they can maintain fiscal discipline. As we go to print, there's talk of a break-up of the European monetary union as the Greek crisis has expanded to affect bond yields of virtually every country except Germany. The market awaits credible action by European authorities to ensure a viable monetary union.

2. We must temper our expectations of a steady, sustainable economic recovery

   Europe looks to be on the verge of recession, the United States continues to lumber along with sub-2 percent growth and the emerging world is showing signs of slowing growth.

Investment Themes to Watch

With that as a backdrop, here are some investment themes that are worth watching in 2012:

• What actions will Congress take during a contentious election year? Certain key issues are in flux, including the deficit reduction policy, income and estate tax rates, exemption amounts and health care reform. In that mix, there's a presidential election, a teetering “occupy” movement and a confused and disillusioned electorate. One party inflexibly refuses to accept any new federal revenue increases and the other inflexibly refuses to make serious cuts to government programs. Not surprisingly, against that backdrop of extremes, we expect that the political environment will matter as much as anything in 2012, fueling uncertainty.
• How will the European crisis resolve? Even if European politicians make hard decisions to salvage the European monetary union and the health of its constituent countries (see point 1 above), there's a risk of a vicious cycle in 2012. European bank balance sheets, already under pressure from new Basil III capitalization requirements, are likely to be further stressed by European sovereign debt (held as core capital) if they suffer further paper losses, giving rise to a need for greater and better capital. That, in turn, bodes poorly for core European economies, like France and Spain, whose gross domestic product is comprised of the banking sector. And so on.
• Will China and India have a “soft” landing? These economies continue to grow at high single digits, two and three times the U.S. economy, with lots of evidence to suggest that domestic demand (not global demand) can support continued growth at that rate. But these economies don't exist in a vacuum. If European and U.S. consumers remain stultified, hurting Chinese and Indian manufacturing, will the local consumer become more defensive and slow down?
• Will the U.S. consumer recover? The U.S. consumer spoke with his wallet in 2011. Unfortunately, instead of opening it and spending, he stayed home and saved. Consumer confidence remained low this past year, further complicating the U.S. economic recovery. Recently released U.S. retail sales figures and a declining (but stubbornly high) unemployment rate offer hope, but the housing market shows no signs of turning and significant anxiety persists.

So, what's the prudent action to take? Given today's low interest rates, the outlook for bonds is muted. High quality bonds can offer stability for a portfolio, should troubles persist. Equities, on the other hand, are neither unusually expensive nor unusually cheap and offer attractive returns relative to bonds for the long-term investor who can hold on through what's likely to continue to be a bumpy recovery.

— The views expressed in this article don't belong to any particular participant but reflect an amalgam of various views, none of which (individually or aggregated) represents the views of JPM, Bernstein or Lazard. This article is intended purely for educational purposes and nothing herein should be construed as investment advice or the solicitation to buy or sell any securities.

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Clockwise from far left: Edward J. Finley II is a managing director at J.P. Morgan Private Bank in New York; Gregory D. Singer is the director of research in the Wealth Management Group at Bernstein Global Wealth Management in New York; Andrew M. Parker is a managing director and chief portfolio strategist of Lazard Wealth Management in New York

SPOT LIGHT

Shipwrecked

“A Stiff Onshore Breeze With a Dismasted Merchantman Foundering on the Rocks,” (11 ¼ in. by 15 ¼ in.) by William Joy, sold for $1,937 at Christie's Maritime Art Sale in London on Nov. 24, 2011. William and his brother John were known in the art world at the time as the “Brothers Joy.” He was discovered by Captain G.W. Manby, famous in his own right for inventing the portable fire extinguisher.