Investors should meet 2012 with a defensive posture, recommends Richardson GMP Ltd. in a new research report.

In a report setting out the firm’s outlook for the year ahead, the investment dealer says, “Looking at the TSX index and the Canadian capital markets, our outlook for 2012 is one where cautious optimism is warranted.”

That optimism is rooted in expectations for a soft landing in China, and signs of recovery in the U.S., which, it says, “we think bodes well for equity performance towards the end of the year.” However, the market’s performance in the first six months “will depend greatly on developments in Europe,” which will likely mean heightened uncertainty, it adds.

“Overall, we remain positive about the longer term outlook for Canada and the TSX index… However, we can’t ignore the debt crisis in Europe nor our significant economic reliance on the United States, which keeps us cautious in the near term. We believe defensive stocks will continue to outperform to start off the new year,” it says.

“The global economy continues to struggle under the weight of fragile business confidence, the lack of policy response from officials in Europe, and a persistently weak labour market recovery. Since the global economy remains vulnerable to shocks emanating out of Europe, we expect the high level of market volatility we have experienced since last summer to continue in the first half of 2012,” it says.

While relatively low equity valuations suggest stocks are more attractive than bonds at the moment, the report notes that given the political uncertainties hanging over the global economy among other headwinds, it remains more neutral towards stocks for the year ahead. “We maintain our preference for a defensive sector positioning with a focus on quality earnings and dividend growth. In Canada, that includes the financials, telecoms, and pipelines & utilities. In the U.S., we favor healthcare, consumer staples, and technology.”

Additionally, it says that its cautiously optimistic outlook also bodes well for the Canadian dollar, which it believes “will have the chance to pass through parity once again”. Although if turmoil in Europe intensifies, it cautions, the U.S. dollar will surely benefit.

On the monetary policy front, the firm says that there’s a possibility that the U.S. Federal Reserve Board will need to pursue further easing measures in the year ahead, either by increasing purchases of Treasury bonds, or by increasing purchases of mortgage or other asset backed securities. It also expects the Bank of Canada “will need to step in and lower rates in the first half of 2012.”

In the bond market, Richardson GMP says that it believes the high yield sector “offers compelling value”. While default rates are expected to rise slightly from the current very low levels, they are expected to remain well below the historic average, it says, adding that the spread on high yield bonds versus Treasuries is expected to narrow, “which in turn will translate into strong price performance of the high yield indices.”