Market strategists favor stocks in 2013

One predicts a 10% return even though economy is expected to grow slowly

Jan 9, 2013 @ 3:56 pm

By Andrew Osterland

Experts see the U.S. economy continuing its slow growth pace and low inflation trajectory for 2013, and expect stocks to outperform bonds.

The three panelists on an InvestmentNews webcast — “Beyond the Fiscal Cliff: What's Next for Stocks and Bonds,” were all of a mind that the U.S. economy would continue to show sluggish growth in the first half of the year largely due to the ongoing turmoil over fiscal policy in Washington.

“Domestic growth is realizing a low ebb now because of the uncertainty of the debt ceiling issue and the congressional debates on spending cuts,” said Jim Russell, chief equity strategist for U.S. Bank Wealth Management. “It will likely have a hangover effect on business and consumer confidence.”

Mr. Russell expects that GDP growth of just 1% in the first quarter will accelerate to 3% by year-end. He estimated that earnings for S&P 500 companies will grow by 6% and has a year-end target of 1,570 for the S&P 500. With a dividend yield of 2%, that would amount to a total return of over 10% for the year.

Nicholas Colas, chief market strategist for ConvergEx Group, has similar views of the economy this year with the caveat that the 2% increase in the payroll tax that went into effect Jan. 1 may have a significant effect on consumers.

“Tax rates went up for every working American, and I'm not sure what the effect on confidence and consumer spending will be,” said Mr. Colas, who described himself as cautious for 2013.

He also expressed concern with what the Federal Reserve would do if the economy were to show growth in the 2% to 3% range.

“The fact that the Fed has been talking about the end of QE [quantitative easing] is an important macro factor, and it could cause some shock in the markets,” Mr. Colas said.

Brian Gendreau, a market strategist for Cetera Financial Group, generally agreed with his peers' assessment of the U.S. economy. He expects the housing market to continue its recent improvement and sees moderate growth in consumer and business spending offsetting some fiscal tightening by the government this year.

With the forward-price-earnings ratio currently 12 on the S&P 500, he too favors stocks over bonds. “There's a perception that stocks can't do well in periods of slow growth,” Mr. Gendreau said. “We don't think that's true.”

He sees a bias towards rising interest rates and is “worried” about bonds. He favors spread products with the idea that higher-yielding corporate bonds could cushion a rise in prevailing market rates.

Mr. Russell, by contrast, says the corporate bond market is in the “seventh inning” with the big gains already having been realized. He leans towards municipal bonds, given the current tax environment and the strong possibility that tax rates could be headed higher still. He also favors investing in individual bonds rather than funds, which he expects will see significant price erosion when interest rates begin to rise.

The three strategists generally agreed that Europe will remain mired in a near-recession slump, though a significant crisis is unlikely this year, given the more active role of the European Central Bank.

“Europe will stay stuck in first gear but we don't expect any more brush fires,” Mr. Russell said. He called emerging markets “the exciting place” for 2013, with the optimism centered on recovering economic growth in China.

All three panelists see the continuing debt negotiations in Washington causing potential volatility in the markets in the beginning of the year. “I'm worried the political process is more broken than we realize,” said Mr. Colas.

The recent discussion of the Treasury's possibly minting a $1 trillion platinum coin to skirt a showdown with Republicans over the debt ceiling is a particularly bad sign. “It would be a dramatic change if the president is willing to unilaterally shift the balance of power between the executive and legislative branches.”

Mr. Colas didn't mince words about how politics is likely to affect financial advisers and their clients. “The government is targeting your client base,” he said. “There could be changes in deductions and in the tax code, but tax rates will go higher from here.”

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