Having started the year robustly enough, the outlook deteriorated sharply as the year progressed, with investors facing the prospect of recession (and some would argue depression) and even questioning the future of the financial system. Faultlines were evident early on, with civil unrest in the Middle East spreading to Libya and resulting in oil prices rising to a two-and-a-half year high. Japan then suffered a huge earthquake, tsunami and nuclear incident in March, causing supply chain issues for much of the year.

The real test for investor nerves came over the summer. Fears centred on Europe, with many nations suffering from high sovereign debt to GDP levels, budget deficits and low growth. While this focused on peripheral Europe until the autumn, signs of contagion spread to larger nations such as Italy and Spain as bonds yields rose through 7% and 6% respectively. This in turn put pressure on the banking sector, a significant holder of sovereign debt, and concerns resurfaced that many in Europe would need to recapitalise or accelerate deleveraging (lowering debt levels). Furthermore, as bank funding costs rose, their ability to finance themselves was restricted, preventing them from supplying credit to the real economy. Another challenge faced by markets was one of slowing economic growth. Global growth had been recovering steadily since the end of the recession caused by the 2008 financial crisis (albeit rather unevenly, with muted growth in developed regions and much stronger figures in emerging markets).

Moving through 2011 however, this growth started to fall rapidly. In January, the IMF forecast 2011 GDP growth in advanced economies of 2.5% but had revised this down to 1.6% by September. Emerging economies continued to benefit from structural growth drivers but were not completely immune from the slowdown in the developed world, having to raise interest rates in their battle against inflation.

As a result, the IMF cut its 2011 growth forecast from 6.5% to 6.4%. All in all, the combination of slowing economic growth and fears that the euro and even the European Union may cease to exist in their current forms saw investors flee riskier investment categories such as equities and commodities, as the chart below shows. They looked for solace in traditionally defensive areas such as ‘safe haven’ government bonds and gold. Unusually high levels of volatility in the value of different types of investments was evident for much of the year.