Market Perspectives - January 2013

2013 outlook: Love risk by managing it

Asset allocation

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

Investment horizons

For investors with an investment horizon of three years or longer, we recommend a strategic overweight to equities relative to fixed income. Over the next three months, we think investors can still be rewarded by looking at higher-yielding fixed-income investments as well as growth-oriented equities.

Equities

Within the equity portion of a portfolio, long-term, we think investors should look globally for opportunities. There is no one sector or country that has a monopoly on opportunities. Eurozone and Japanese equities have been battered down, as have Chinese nonbank equities, to the point where we think they represent compelling long-term investment opportunities. In Japan, there is the risk that a rapidly depreciating yen could offset any gains in securities in local-currency terms, so the outlook for monetary policy in Japan will need to be closely monitored. There is also a profound amount of pessimism built into U.S. equity prices. We think all sectors have at least a nugget of investment opportunity.

Value versus growth

We think the U.S. and global economies will grow more rapidly over the next few years than what is embedded in stock valuations across the value/growth spectrum. We tend to prefer mispriced growth opportunities, which are those companies whose growth potentials are underappreciated by the general market. We see many of these opportunities in global health care and technology names. Please note: When it comes to technology, we are not just referring to information technology but rather all those companies that help other companies convert their inputs into outputs in a more efficient way.

Large caps versus small caps

A high-quality company is a high-quality company, whether large or small cap. Generally, large-cap companies have easier access to credit markets and global markets than small-cap companies, but that is not always true. There are many large-cap companies that have cash burning holes in their executives' pockets that could lead to imprudent acquisitions. As a result, we think it's also important to focus on corporate governance.

Fixed income

Based on our economic outlook, we believe that interest rates are likely to remain low for the next year. This presents an opportunity for investors to take on additional duration and credit risk. Provided the economy does not dip into a recession, default rates should not increase, meaning increased yields on higher-yielding debt may provide better income to investors than the lower-credit-risk issues would.

Asset allocation summary table1

Equity recommendations
Strategic recommendation
Three years
or longer
Tactical recommendation
Less than
one year
 
Developed equities/emerging markets equities
Emerging markets have likely been oversold due to dire predictions about global economic growth. Emerging markets are likely oversold, but considering the short-term uncertainty, we think it remains prudent to focus on global developed equities. Developed equities/emerging markets equities
U.S. equities/non-U.S. developed equities
The ability to grow market share will likely be more important than the ability to grow earnings. Valuations are attractive outside the U.S., but growth estimates of the U.S. economy are likely too negative. U.S. equities/non-U.S. developed equities
Value/growth
Look for real growth, which can be in traditional value sectors. We think the theme for the next few years will be to identify mispriced growth opportunities. That means looking for value stocks in growth sectors and growth stocks in value sectors. Health care and technology (not just information technology) remain our favorite areas. Growth with value characteristics or value with growth characteristics seems to offer the best investment opportunities. Value/growth
Large/small
Overweight large-cap stocks because they tend to have the dominant market share and cash to survive a volatile environment. Large-cap stocks are attractive, but some large-cap companies may be tempted to overpay for acquiring small-cap companies. Large/small


Fixed-income recommendations
Strategic recommendation
Three years
or longer
Tactical recommendation
Less than
one year
 
Fixed-income duration
The Fed claims that rates will remain low until unemployment falls below 6.5%. We think that could happen before the Fed's forecast of mid-2015. Thus, we believe you can ride low yields for a while, but not forever. The Fed and other central banks will likely keep shortterm rates low until at least the end of 2013. Thus, we think there is little reason to fight the central banks. Fixed-income duration
Credit risk exposure
Default rates are low, but investors need to be careful about new issuances. Some of the credit risk might not be worth taking. We think default rates will continue to fall, which should be good for high-yield debt. But it pays to be cautious, as junk issuers are getting too good of a deal. Credit risk exposure
Fixed rate/floating rate
We prefer fixed-rate short-term debt over floating-rate debt. Until the end of 2013, buying floating-rate debt might be like buying insurance for an unlikely event. Some floating-rate debt may be prudent, but it really depends on the credit quality of the issuer. In general, we'd prefer to leave the decision to a portfolio manager who does bottom-up credit analysis. Fixed rate/floating rate

 

 

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