"This Washington stuff is a bigger deal than ever," says Adam Parker, chief U.S. equity strategist at Morgan Stanley. "There' s no bull case without policy clarity."
Indeed, financial markets next year will be driven more by politicians than price-to-earnings ratios. The panelists expect headlines related to the nation's fiscal situation to be a major market mover, as has been the case since the November U.S. elections, which resulted in maintaining a divided Congress.
How and when - and if - a deal gets sealed is critical to both the health of the economy, as well as consumer and investor confidence.
"Policy and politicians are much more dominant now," says Liz Ann Sonders, chief investment strategist at Charles Schwab. "It is a tricky thing and sort of the ultimate wildcard."
The general consensus is that a short-term deal to avert the fiscal cliff will get done by year's end, which should spark a short-term relief rally. But panelists warn that the market could suffer a correction after the initial euphoria as investors are expected to switch their attention back to the damage to the economy and corporate earnings that has already been caused by all the uncertainty. Investors also will have to wait to see if Congress can hammer out a "grand bargain" on tax and entitlement reforms needed to put the country on a sustainable growth trajectory.
If the "policy cloud diminishes," as Thomas Lee, chief U.S. equity strategist at JPMorgan Chase, predicts, the market is likely to enjoy a strong year-end rally.
Overall the panelists' projections for the new year range from roughly a flat market to one that enjoys gains of 10% or more.
IS THIS A GOOD TIME TO OWN STOCKS?
It's been a wacky, volatile year on Wall Street. The U.S. stock market is up more than 12%, but it doesn't feel that way. Investors are still jittery and still staring down angst-inducing headwinds: political and policy uncertainty; the "fiscal cliff"; the still-weak U.S. economy; Europe's debt crisis; slowing global growth. And it raises the question: Is this a good time to own stocks? Is it worth the risk?
USA TODAY: Bob, do you think stocks will trade higher again next year?
Bob Doll, chief equity strategist, Nuveen Asset Management: It is harder than usual (to forecast). There are so many variables that can make a difference in either direction. Fiscal cliff: What do the politicians do? What does a deal look like? How much does it hurt?
Europe has kind of moved off the front page, but they haven't solved their problems, and it is going to be back at some point. Corporate earnings in the third quarter of 2012 were not so good (up 0.1%, Thomson Reuters says.) I'm not sure the fourth quarter is going to be a whole lot better (estimate is +3.2%). My view is we're seeing a bottoming process for earnings, but I don't think the trajectory on the other side is (super robust). We also have a lot of hot spots around the world, and many of them affect the price of oil, and that can be a problem.
While confidence is improving and housing prices are moving up, there is still this malaise, this pall, this, "Don't tell me the market has doubled in the last three years, I don't believe you!" That type of mentality.
USA TODAY: How does that translate into your forecast?
Doll: I have just described a wall of worry and I think we continue to climb it. The more likely direction for stocks will be up, rather than down. My price target for the Standard & Poor's 500-stock index is 1550 (a gain of 10% from Friday's close of 1413.58). That puts the market on the precipice of new highs.
USA TODAY: Any other bulls out there?
Thomas Lee, chief U.S. equity strategist, JPMorgan Chase: Yes. But the timing of the gains is what is tricky. Next year is going to be a year of contrarian timing. The first half of 2013 is tricky because the market will be vulnerable to a sell-off. We expect investors to start the year very optimistic about 2013. This means the market could perform very strong in the first month or so. But it also means a contrarian sell signal is likely triggered - as the market rarely continues to rise when everybody is optimistic. The big rallies and sustained rallies take place when consensus is pessimistic.
USA TODAY: So where does your bullish call come from?
Lee: 2013 will mark the start of the fifth year of the bull market. (Barring a 20% drop, the bull will celebrate its fourth birthday on March 9, 2013.) Only five bull markets have managed to live that long. We are in rarified territory. The average gain in year five is 20%. So, simple math says 1700 on the S&P 500. But ...
USA TODAY: But what?
Lee: But my price target for the S&P 500 is 1580 (a 12% rise from Friday's close). What is tricky is I think all of the clients I speak to who really are frustrated with this year are going to become constructive on the market on Jan. 1. I think they're going to bet that 2013 is a breakout year.
That's where the contrarian timing comes in. The reality is that we are probably going to have a pretty lousy first half.
USA TODAY: Why the call for a first-half fade?
Lee: A number of reasons. Whatever deal comes out of Washington, there is going to be an adverse impact on earnings and the economy. So growth, or GDP, in the first half is weaker. There will also be lingering concerns about the implementation of any cliff deal and the president's health care law, and that will likely compress price-to-earnings multiples.
I also don't think Europe is exiting recession until the second half of next year. I also think investor sentiment will be too bullish in the first half. As a result I think we'll see the S&P 500 dip to around 1300 or 1350 (a drop of about 4% to 8%).
USA TODAY: So what's the catalyst for a late-year rally?
Lee: One of our themes has been (to bet on the recovery in) housing, which is going to be the point man for a bigger durable goods recovery. The second-half really is when you start to see a much more visible recovery in durable goods spending, construction activity and capital spending. As a result, earnings and revenue growth will reaccelerate. Companies are cautious now, but the second half of 2013 looks a lot better.
USA TODAY: Any cautionary tales?
Ann Miletti, senior portfolio manager, Wells Fargo Advantage Funds: I am coming from a different place, because in talking to management teams we're seeing a lot of caution. They are sitting on their hands, not wanting to spend capital, not wanting to hire.
There has been real concern because of all of the uncertainty, whether it's the fiscal cliff, or unresolved issues like tax policy and regulation. Companies want to know what the rules of the game are. Once we get more clarity, they'll actually start to engage. They will not be able to sit on their hands for another four years and do nothing.
USA TODAY: So you expect companies to go back on the offensive?
Miletti: They will start to spend. Hopefully, as a result, we will see at least a moderate amount of economic growth. We're thinking it's going to be a continuation of what we have seen this year, a slog-type environment, just very slow growth. Our goal is to find companies growing faster than the market, which is going to be a challenge. But I think it still will be an up year for the stock market. By "up," I'm thinking 5% to 8%.
USA TODAY: Liz Ann, are you bullish or bearish on stocks?
Liz Ann Sonders, chief investment strategist, Charles Schwab: My base case is not all that unique from everybody else's. There is a two-step process as it relates to the fiscal cliff. Almost all of the focus right now is on the time frame for a deal, something between now and year-end. I think you get a sigh-of-relief rally, upon almost any deal structure. The idea of falling off the cliff has diminished. The second phase is actually looking at the devil in the details and figuring out what the longer-term economic consequence is going to be. But I agree that a lot of the economic impact is already being felt in 2012. It has also affected the analysts' ability to accurately forecast the 2013 earnings numbers because they don't have everything they need - tax rates, health care costs - for their input model. There is a lot of criticism that the numbers are too high.
USA TODAY: So where does your optimism come from?
Sonders: I am a contrarian by nature, and I am always more intrigued by stories that very few are telling than stories that everyone is telling. The story of the U.S. economy not getting much past stall speed, to maybe 3% growth, is still superior to the rest of the world. I can't help but think, OK, if we don't get that, is it more likely to be much worse or much better? My bias is toward much better. A big year next year would come in a huge end-of-year rally.
USA TODAY: Why are you leaning toward a better outcome?
Sonders: There are aspects to the housing recovery that are underappreciated. You not only have record-low mortgage rates now, but the asset itself - the real estate - is going up in price again. That to me is what is pulling buyers off the fence. That is one of the seeds for recovery. A potentially bigger boost relates to jobs. There is a 15-month lag between positive changes in housing and the unemployment rate (falling). We are just at the sweet spot.
USA TODAY: Any other reasons for optimism?
Sonders: Another big story that is only starting to capture the broad mind-set is the manufacturing renaissance and improved competitiveness in U.S. manufacturing and domestic energy. The last cycle was about the creation of paper wealth. We are actually going to be producing and exporting things again.
USA TODAY: Adam, your year-end 2013 target is 1434, which is basically a call for a flat market. Why so cautious?
Adam Parker, chief U.S. equity strategist, Morgan Stanley: We're forecasting a low-single-digit return. About a 4% total return including dividends. The long-term average is closer to 8%. We don't think it's going to be any better than an average year.
In thinking about a year-end target, you have to have a view on corporate earnings and the multiple investors are willing to pay for those earnings. My confidence level in the earnings is a lot higher than my confidence level in the multiple.
(To forecast) earnings, we use macro factors, such as data on GDP, payrolls and manufacturing. The good news is I think earnings trough in April and can actually begin to grow in the second half of 2013, based on what we know now.
The bad news is the consensus view for 2013 S&P 500 earnings (is $113.19 per share and that appears too optimistic). The earnings estimates have to come down. Our estimate is $98.71 in earnings.The question is: Do investors get really afraid as the estimates come down? One of the differences between next year and last year is nobody is bearish about 2013 earnings.
USA TODAY: So the market will get a lift from the earnings rebound?
Parker: My suspicion is the market will hold in OK, as long as there's not a lot of fear growing about a big spike in oil prices, Europe looking much worse on the economic front, or the fiscal cliff really spooking people. I tend to agree that you can see the market sell off earlier in the year and then rally, but we will have to see the earnings improvement. I have a much more cautious long-term view because, to me, there is no bull case without policy. This is a confusing year. We want to pick stocks with growth rates better than the market, but it's hard to do that when you don't even know what the rules are.
USA TODAY: Dan, where are you on the market?
Dan Chung, CEO and chief investment officer, Alger: I am in the 1550-1600 camp, which translates into a gain of more than 13%. We have had a rally on fading fundamentals in the second half of 2012. Investors are now clearly focused on the fiscal cliff, whether we get a deal, a grand bargain or we go over the cliff.
The way the markets are acting it is very clear to me that we get a rally when we get some resolution of the fiscal cliff uncertainty and a move toward a grand bargain (to put the nation on a more sustainable fiscal path). But I think it is a rally that will fade pretty rapidly. There will be high volatility, probably a downward bias until maybe a huge fourth-quarter rally.
USA TODAY: Why don't you think that, at first, the gains won't stick?
Chung: We will get a sentiment rally on the deal, but we will see the effects of all this uncertainty in the economic and earnings numbers in the fourth quarter of 2012 and first quarter of 2013. And when you finally do get the grand deal, there will be a lot of uncertainty, especially if it is a messy one, or one that is drawn out. People will ask: What does this mean for me? Will the mortgage deduction be capped or not? Will entitlements be cut or not? The longer Washington drags this out, (the worse it is for the market).
USA TODAY: So you expect stocks to go lower early in the year then stage a late-year rally?
Chung: Yes, I think we are capped on the upside in the first half of the year or first eight months due to the uncertainty around whether a fiscal cliff deal happens or not. That is downside risk. I am fearful that it won't be until summer when we get clarity from Washington.
And, remember, Europe is not resolved. German Chancellor Angela Merkel is also up for re-election in the fall. It will be difficult to see a lot of progress in Europe until she has that election in hand. There may be more fighting and tension (regarding bailouts of peripheral eurozone countries) before there is a resolution.
But then what I see, what makes it difficult, is we do get a fiscal deal, and we do move forward. Investors will see that while fundamentals have slowed, they are better than they thought they would be, despite all of the uncertainty. But they will have to see the second-quarter 2013 profit numbers and maybe even the third-quarter numbers (before they get bullish).
I see a major rally, based on fundamentals, late next year that starts a really strong bull market.
WILL THE FED FUEL GAINS AGAIN 2013?
USA TODAY: Where do you stand on the role of the Fed in propelling markets forward again next year? The Fed said last week it would keep short-term rates near zero until the jobless rate, now 7.7%, falls to 6.5%. It also announced a fourth round of bond buying, or quantitative easing, saying it will buy long-term Treasury bonds and mortgage-backed bonds to keep rates low.
Miletti: The market has paid less and less attention to each Fed action. There has been less of an impact on the stock market with each successive Fed action.
USA TODAY: Why?
Miletti: As an investor, I pay less attention to that and look for real fundamental growth coming from companies specifically, instead of the Fed.
Doll: Monetary policy in 2013 is not about the Fed. It is about Europe and China and Japan. The U.S. Fed has led the way and will continue to do what they have been doing. What we have seen in China is after they have eased, the economy has stopped falling and arguably is doing a bit better. I think Europe, both for financial stability and for economic growth reasons, will step on the accelerator again, and probably Japan as well.
Lee: Japan could do something very big, too.
Sonders: Global central bank policy has been more important in the last year or so because inflation has not broken out. We have not had that kind of global easing in a synchronized way since 2008. One of the keys next year I think will be inflation (remaining tame) and whether global central banks can keep the flow (of liquidity and cheap money) open.
USA TODAY: So the Fed is still in play?
Parker: Monetary policy is a big deal. If you talked to 10 investors, all 10 say the Fed will do more QE. It has big implications for the kind of stocks that work. It is a big deal for the U.S. stock market.
This Washington stuff is a bigger deal than ever. I think the Fed is really clear that they will keep buying more securities. The Fed will keep yields low. I think there will be unlimited QE (quantitative easing, the Fed's unconventional policy of buying government bonds and mortgage-backed bonds to keep borrowing costs low).
CHUNG SEES APPLE STOCK REBOUNDING TO NEW HIGHS
If there was one stock that has captured the imaginations of investors in 2012, it was iPhone and iPad maker Apple, the world's most-valuable company and most-owned stock. The stock hit an all-time closing high of $705.07 on Sept. 21 and was up nearly 75% this year, before tumbling almost 30% late in the year to $509.79. In last year's Investment Roundtable, Apple was one of the top stock picks of panelist Dan Chung. While Apple remains a top holding at Chung's Alger money management firm, Chung, who is again serving as one of our panelists, did not cite it as one of his top picks for 2013. USA TODAY reporter Matt Krantz asked Dan what's going on with Apple shares.
USA TODAY: What do you think of Apple?
Dan Chung, Alger: Actually, we like Apple, it is a top holding. I would not sell it.
USA TODAY: Why is it going down?
Chung: There are a couple things. First of all, you have some selling of big winners, and this is one of the biggest winners on a multiyear basis that people have, and it is a stock held by index mutual funds. If anybody will sell anything, they will sell Apple.
Some funds have 7% of their assets invested in Apple. There is also selling by individual holders. (Some investors are selling for tax reasons as they try to avoid paying potentially higher tax rates next year.)
The concern, of course, is that the rate of innovation is sort of slowing and the competition is catching up.
USA TODAY: Are investors overreacting?
Chung: I would argue that this company deserves the benefit of the doubt in terms of innovation going forward. I think you will see surprisingly good numbers from the iPad Mini, iPad 3 and iPhone 5. The stock is really cheap. You talk about free cash flow; it is amazing. It is above 10%.
USA TODAY: Do investors miss late CEO Steve Jobs?
Chung: New CEO Tim Cook and his management team are doing some interesting things with the company. Cynical investors that are selling the stock are not paying attention to the new management. There is quite a bit of fire power financially. Apple has about 20% or more of its market cap in cash. It is also trading at (a below-market price-to-earnings ratio) of about 11 times earnings. The stock is still up close to 26% for the year.
USA TODAY: How high can Apple go in 2013?
Chung: I think the likelihood of a rebound to the $750 level is very high.
ARE THEIR ANY BLACK SWANS THAT POSE BIG RISKS OR OPPORTUNITIES?
Forecasts don't take into account so-called Black Swans, those unpredictable, unexpected, unfathomable events that can turn a bullish outlook bearish, or transform a pessimistic forecast into one of unbridled optimism overnight. "We spend a lot of time worrying about the knowns," says Ann Miletti of Wells Fargo Advantage Funds. "But it's always the unknown that people can't or aren't pricing into markets."
So what event could surprise financial markets and move markets further and faster than anyone predicts? Let's start with bad outcomes.
"An explosion in the Middle East," says Dan Chung of Alger Funds. "Conflict in the South China Sea."
"Anything that could cause a threat to national security here at home," says Ann Miletti of Wells Fargo Advantage Funds.
"Civil unrest and labor unrest in the USA," says Adam Parker of Morgan Stanley. "That would pose a greater problem than the Occupy Wall Street movement."
What about so-called White Swans, or upside surprises?
"Stocks have gone up more than 100% since March 2009 with just one buyer: the corporation," says Bob Doll of Nuveen Asset Management. "Can you imagine if a second buyer - the individual investor - showed up?"
"Let's suppose we go over the fiscal cliff and four or five or six months later, the market realizes, after seeing the fundamentals, that this was not that bad," says Chung of Alger. "That it actually fixed the problem, maybe in a stupid mechanical way, instead of kicking the can down the road."
A bipartisan Congress! "Look what happened in the early '80s, when you had Republican President Ronald Reagan and Tip O'Neill, the Democratic speaker of the House of Representatives getting together to do a deal on major tax reform," says Liz Ann Sonders of Charles Schwab. "It was a phenomenal boom for the economy."