Market Perspectives - January 2013

2013 outlook: Love risk by managing it

The bottom line

With all the volatility in the markets during 2012, some investors might have forgotten that 2012 was actually a pretty good year for the bond and stock markets. There were lots of political changes—the U.S. election, the 18th Party Congress in China, and the Japanese election, to name just a few.

The year 2013 will also be host to a number of political changes that could move markets—the Italian election, the Iranian election, and the German election, to name just a few. The prospect of these changes could frighten some investors. However, we’re still forecasting moderate U.S. and global growth against the backdrop of mild inflation. That’s why we think investors who focus on risk management instead of risk avoidance could enjoy decent returns in 2013.

We expect 2013 to be a notable year for equities. Our year-end target of 1,600 for the S&P 500 Index implies only a 14 times to 15 times trailing multiple on our predicted $111 in earnings for this year and less than a 13 times multiple on our 2014 predicted earnings of $125. No doubt, the year will be filled with surprises, but given the level of concern among investors, we suspect the majority of true surprises will be positive. We also expect the world to continue to work through its problems and think that some of the fruits of those efforts will appear in the next 12 months.

Even after four years of generous returns from virtually every segment of the bond market, we continue to believe that it is still too early in this investment cycle to be in cash and cash equivalents. Because this is such an unusual business cycle, most fundamentals continue to suggest that short-term rates will stay low for at least another year, keeping returns from cash equivalents near zero. More importantly, low short-term rates tend to prevent bond yields from increasing substantially, especially when yield curves are already quite steep. Continued sizable purchases of notes, bonds, and MBS by the Fed should also help keep most bond yields within relatively narrow trading ranges.



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