What we expect for the economy and the stock market in 2013
Although there are some formidable obstacles ahead of us, we have a fairly positive outlook for next year. We expect the politicians in the U.S. to eventually hammer out an agreement over the fiscal cliff that will limit the potential damage that would be done by failing to act. The agreement will probably fall short of a ‘grand bargain’ and it will include the usual amount of postponement in dealing with the issues directly. Even so, an agreement will likely calm the nerves of businesses and investors enough to allow the global economic recovery to continue.
The U.S. economy should grow at about a 2% pace, Europe should grow about 1%, and emerging economies like China and India should see a return to faster growth, although not quite as fast as recent history.
We expect interest rates in the U.S. to remain low, and that this will continue to favor higher yielding assets such as dividend paying stocks, corporate bonds, and REITs.
Since we are not expecting a recession next year, we remain fully invested in equities in our model portfolios. Once we have more clarity about fiscal policy in the U.S. and Europe, we might even go to an overweight allocation in equities for the models. For now, the obstacles described above, demand a more cautious and conservative posture.
As far as global stock markets, we have a slight overweight in the U.S. and emerging markets, a neutral weighting for Eurozone markets, and a slight underweight for the commodity-heavy markets like Australia and Canada.
In the U.S. market, we favor cyclical sectors like Tech and Industrials over defensive ones like Healthcare and Telecom. We favor small caps over large caps and growth over value. In fixed income, we favor corporate and high yield bonds, and we would avoid Treasuries and TIPS.
Given all of the above, our best guess for the U.S. stock market is a 10% gain, which would take us back to the pre-crisis high of 1565 on the S&P 500 Index. It’s likely to be a very bumpy road, but barring any serious policy mistakes, we should get there by this time next year.