The coming year should pose new questions on how to handle debt internationally and shape up as a new test for the U.S., in what will likely lead to a low-growth environment for investors, a panel of investment experts said this week.

In light of what is going on in Europe, the markets now face the question of is there going to be a recession and how much will it cost in terms of facing those debts, said Lisa Shalett, chief investment officer at Merrill Lynch Wealth Management.

“The only way the banks are going to capitalize is through deleveraging, and by deleveraging, they’re essentially going to pull loans or pull liquidity out,” Shalett said. “They could pull out $3 [trillion] to $4 trillion over the next two years if that’s what they’re forced to do.”

The question of how to handle debt comes as seven major democracies in the G20 will face new elections in 2012, and China will see new power in place. For the U.S., which has already shown some economic resilience, Shalett said, the coming year will serve up more tests as political deadlock has prevented decisions on issues such as the deficit.

“We can all understand the math, and so there’s the problem, there’s the math to fix it, and what’s been significantly absent is political will to get it done,” Shalett said. “This is not the unknown unknown, the thing that investors lose sleep over at night. This is the known known, and we just haven’t gotten it done.”
Colin Moore, chief investment officer at Columbia Management Investment Advisors, compared the U.S.’s debt struggles to a snowball rolling downhill.

“If you let it go too long, it will bury you if you try to stop it,” Moore said. “That’s the rate at which our debt is increasing.”

Another concern in 2012 could be the coming Volcker Rule and its potential impact on market liquidity, said Robert Auwaerter, principle and head of the fixed income group at Vanguard.

The current amount of inventory of corporate bonds that Wall Street firms have on their balance sheets on a daily basis is already at the lowest levels since 2003, Auwaerter said. The Volcker Rule may require firms to now monitor every trade with their compliance teams, he said, which could thus hamper liquidity.

As investors prepare for those conditions, they need to employ strategies anticipating the low-growth environment, according to the panel.

Merrill Lynch is favoring global fixed income, Shalett said, in step with expected for reflation efforts, with central banks already starting to move.

“While I wouldn’t singularly call out Italian bonds, I think there’s money to be made in Italian bonds,” Shalett said.

David Giroux, vice president of T. Rowe Price Group, said his firm is underweight dividend stocks for the first time in five and a half years. With the market putting too high of a value on dividend, the firm is emphasizing companies like Thermo Fisher, which Giroux describes as a double-digit grower trading at 10X earnings.

Christine Thompson, chief investment officer at Fidelity Bond Group, said that the municipal bond market has areas that are appropriately backed by governments. Investors should not treat the municipal bond market as homogenous, she said, and can balance their portfolios with high quality, high yield bond instruments.

“My guess, and the positioning of our portfolios, is anticipating that we’ll continue to have two steps forward, one step back,” Thompson said. “Markets will be volatile, risk assets and less risky assets will continue to gyrate, and successful strategies will be ones that anticipate a low-growth environment into 2012.”

The panel was hosted by Lipper, a mutual fund research company owned by Thomson Reuters, in New York.

Lorie Konish writes for On Wall Street.