Investors can expect to see modest levels of recovery and growth overall in 2012 driven by Asia and the United States, says Russell Investments.

The 2012 Annual Global Outlook points specifically to four themes that Russell believes will have the greatest impact on markets and asset returns in 2012:

1. Global deleveraging will continue to be the backdrop for economics, finance and politics for 2012
Balance sheet recessions are typically followed by elongated, grinding and below-trend recoveries, notes Russell. Lower standards of living, high unemployment, lower returns and higher volatility should all be expected.

2. The key risk to improved market sentiment in 2012 is the euro
Given the fragility of the European banking system, Russell considers potential European policy errors and inaction as the single largest source of systemic risk and threat to global market sentiment.

3. Continuation of a square-root-sign-shaped U.S. economic recovery
Central to Russell’s U.S. economic forecast since 2009, the square-root-sign-shaped recovery is expected to continue into 2012 with gradually improving news on the U.S. economy, ongoing strength of U.S. corporate earnings and expanding pockets of private investment strength. Russell’s target for the S&P 500 at the end of 2012 is 1,300.

4. The expected modestly positive effect of the Chinese/Asian engine of growth
Chinese authorities have just embarked on an easing cycle and Russell’s strategists believe China will likely achieve a reasonably soft landing. Combined with other emerging-market easing, China and these emerging markets will, along with the U.S., once again contribute as engines of growth for global gross domestic product (GDP).

While Russell expects market volatility levels to remain elevated and corporate earnings to slow, the firm’s investment strategists believe moderate profit growth will likely balance the scales to result in positive, albeit modest, global share market returns in 2012.

For 2012, Russell proposes a central, highest-probability scenario that the two engines of the Chinese and U.S. economies will ignite and drive global growth. Assuming this is the case, and if Europe can stabilize their deepening sovereign debt crisis, Russell believes this will result in a notable positive for risk assets.

“While we are more confident on the U.S. and China forecast with each data release, we are acutely aware that forecasting political outcomes is very difficult. We believe that Europe will remain a source of systemic risk,” says Shailesh Kshatriya, senior investment analyst, Canadian strategy group, Russell Investments Canada.

Russell believes that the ongoing crisis in Europe will likely also sap the strength of emerging market asset classes — at least temporarily — as these emerging economies are weighed down by the tightening of credit globally, the knock-on effects to growth and liquidity, and sustained risk aversion. Despite this, Russell expects that strong fundamentals will mean that emerging markets will benefit from a return to risk.

“By contrast, Canada has benefited from four key trends since the recession bottom: a rebound in commodities, resiliency of the banking sector, which in turn fuelled a robust housing market, and with strong housing, there has been insatiable household consumption,” said Kshatriya. “While strength of the Canadian banking sector will remain, we feel some of the other trends are primed for moderation as we head into 2012.”

Russell’s target for the S&P/TSX composite index at the end of 2012 is 12,700.