Promising future for U.S. equities

A nail-biting first half of 2013 could give way to better stock performance as economy improves

Jan 6, 2013 @ 12:01 am

By Jeff Benjamin

Thanks mostly to non-stop bickering in Washington, the year ahead is likely to represent a tale of two equity markets — one as fiscal cliff and budget negotiations are worked through and a second after decisions are settled.

This is essentially how most economists, market watchers and analysts have qualified their equity outlooks for 2013.

Financial advisers might do well to take heed of the message, because in moving through the next few months, that first step could be a doozy. Beyond that, however, the outlook for the rest of the year is not all that bad.

“If we can see our way to the end of 2013, we believe it can be constructive for equities,” said Janet Engels, director of the portfolio advisory group at RBC Wealth Management USA.

The challenge, she added, involves looking beyond what is likely to come in the first part of the year.

SECOND-HALF COMEBACK

“In the U.S., we see the seeds of better growth in the second half, but, before that, there is potential for some negative GDP growth in the first quarter,” Ms. Engels said. “We're looking across the valley of the first half, even though we don't know yet how deep it will be because it is being defined largely by Washington.”

According to InvestmentNews' 2013 Investment Outlook survey, in which 592 financial advisers took part last month, respondents generally expect U.S. stocks to lead all other major asset classes in the year ahead. When asked to identify the asset class they expect to perform best in 2013, the highest percentage of respondents — 33.9% — ranked U.S. equities ahead of emerging-market stocks (31.1%), international stocks (10.2%), emerging-markets fixed income (9.6%), U.S. fixed income (6.6%), Treasuries (5.6%) and international fixed income (3.0%). This helps explain why 44.8% of the advisers surveyed plan to recommend increases in clients' exposure to U.S. equities in the year ahead.

In terms of actual performance, 31% of the respondents think the S&P 500 will finish 2013 at between 1,500 and 1,599, reflecting a gain of between 5.2% and 12.1% from where it was trading at year-end 2012.

The second-largest category of respondents, 25%, pegged the S&P's 2013 finish at between 1,400 and 1,499, representing a range between a 1.8% decline and a 5.1% gain.

The S&P closed the year at 1,426 on Dec. 31, representing a 2012 price gain of 13.4%.

ATTRACTIVE VALUATIONS

Only 11% of the survey respondents expect returns beyond 12% in 2013, but there is some evidence of extreme caution on the other end of the spectrum. About 33% of the advisers surveyed see the S&P finishing the year at 1,399 or lower.

The extreme bearish outlooks do not fall in line with most economic forecasts, especially considering how strong the market was throughout the sluggish economy of 2012.

“It would be hard to argue that the stock market is overvalued right now,” said Brian Gendreau, market strategist at Cetera Financial Group Inc. and professor of finance at the University of Florida.

“You have to consider that the stock market was strong in 2012 despite all the hand-wringing and all the cash sitting on the sidelines,” he added. “I would think it would be a wise move on the part of equity investors to get in now.”

Such perspectives from Mr. Gendreau and others reflect an outlook that goes beyond the heated fiscal cliff debates that dominated much of December.

“The first challenge is the fiscal cliff, and the second is some kind of grand bargain that includes a long-term deal on tax reform and curbing spending,” Mr. Gendreau added. “But the main support for the equity markets is that valuations are still attractive.”

The S&P's forward price-earnings ratio, which stands at about 12, implies an earnings yield of about 8%. That is typically considered a good indicator of the future real return for stocks.

Even with the looming uncertainty hovering over the U.S. economy and other world events of potential consequence to markets, the advisers surveyed by InvestmentNews generally favored increasing exposure to stocks over most other asset classes.

BROAD STOCK APPEAL

Along with the 44.8% intending to advise clients to increase their allocation to U.S. equities, 51.4% of advisers will recommend increases to emerging-markets equity; 35.7% will suggest higher allocations to international equity.

Even the tilt toward emerging markets can be interpreted as bullishness on U.S. stocks, according to Erik Ristuben, chief investment strategist at Russell Investments.

“A continued recovery in the U.S. is good for the emerging markets, and in the U.S. we expect the economy to grow at around 2% in 2013,” he said. “For the start of the year, we've always expected some short-term volatility from the fiscal cliff debate, but on balance we think the emerging-market equities will have a better year than developed markets.”

Rob Haworth, senior investment strategist at U.S. Bank Wealth Management, also subscribes to the theory of 2013 being a “tale of two halves.” But he added: “Whether we go over the cliff or not, the first half of the year will be sluggish.”

From his perspective, it could all come down to a test of consumer confidence in the year ahead, as well as some increased spending and hiring by the private sector.

“Deleveraging in our economy will continue, so revenue growth will continue to struggle,” he said. “The real growers that are gaining market share have an advantage in this kind of market, and it's basically a dividend-growth play, which typically comes from companies that are growing revenues.”

The appeal of dividends, driven in part by the thirst for income during a period of record-low interest rates, also falls in line with survey respondents' expecting more from value stocks in 2013.

"VALUE PLAYS'

When asked which investment style would likely produce higher returns this year, 58.9% of advisers chose value stocks over growth stocks.

“We've seen dividends play heavy, and classically those are thought of as value plays,” said Mr. Haworth.

jbenjamin@investmentnews.com Twitter: @jeff_benjamin

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