2013: A Look Back And Ahead
Mutual funds invested at home and abroad enjoyed a banner year
in 2012 despite constant worries.
Topping the worry list were slower global economic growth,
developed markets' sky-high government debts and unemployment
rates, Japan and the eurozone falling back into recession, the
year-end U.S. fiscal cliff debate and turmoil in the Middle
If Wall Street forecasters are correct, investors can expect
high single-digit returns in 2013. Investment strategists at
major investment houses expect the S&P 500 to return about 8%
in 2013, citing studies of previous bull markets, low interest
rates and consumer and corporate spending trends.
Most mutual fund categories across the board scored handsome
double-digit gains. The only ones to lose money were those
betting on bear-market strategies and commodity producers --
mainly precious metals and energy.
The average domestic stock mutual fund returned 13.87% vs.
17.69% for the average world stock funds, according to Lipper
Inc. European and Pacific Region funds outpaced all world
markets, returning 22.24% each.
"You don't need macro growth to generate good returns," said
Stephen Goddard, founder of Richmond, Va.-based The London
Company with $4.5 billion in assets under management and
subadviser of Touchstone Mid Cap .
He believes the Federal Reserve juiced the market most in 2012
as rock-bottom interest rates allowed companies to borrow money
cheaply to make acquisitions or buy back shares, which boosts
earnings per share. But overall because of political
uncertainties, companies hoarded cash instead of hiring more
people or expanding capacity.
"A vast majority of companies have no debt and have more free
cash flow than ever," said Goddard. "And they're trading at 30%
to 40% below their private market value. The gap gets closed
through buybacks and mergers. If valuations stay where they are,
you will see more merger activity."
S&P 500 cash and marketable securities balances in the
third quarter rose 5.8% year over year and 4.1% from Q2 to a
record of $1.23 trillion, according to FactSet. Cash inflows from
debt issuance rose a ninth quarter straight to $32 billion in the
third quarter. But dividend payouts and stock repurchases dropped
17.5% year over year and 4% over the second quarter.
FactSet notes the "declines were primarily due to volatile
share repurchase activity in prior periods."
Goddard's fund returned 19.5% in 2012. It gained an average
annual 14.38% the past three years and 0.24% the past five years.
The S&P 500 averaged 10.87% and 1.66% over the same
Retailers and capital goods producers, or consumer
discretionary, offer attractive values while consumer staples,
trading double-digit earnings multiples, are overvalued, he
Goddard recommends avoiding real estate investment trusts, or
REITs, and master limited partnerships because valuations are
getting lofty. "Investors have bid them up because they want
yield," he said.
The S&P 500 returned nearly 16% including dividends in
2012. It is trading at about 14 times earnings, a valuation
that's typically seen when the benchmark 10-year Treasury note
yield is about 6%. With the rate at 2%, the S&P should be
trading at 20 times earnings at least, Goddard contends.
BofA Merrill Lynch Global Research projects the S&P 500
will rise to 1600 by year's end, up 12% from its 2012 close at
1426, and surpassing its prior high of 1576 from October
The price gains will come from S&P companies growing
earnings by 7% to $110 a share, following 5% EPS growth in
The S&P is still relatively undervalued, trading at
discount to its average price-to-earnings ratio of 16. Although
S&P earnings soared to new highs in 2011, the S&P failed
to do so, suggesting it should eventually catch up.
JPMorgan's investment strategists also see 12% upside in the
S&P for similar reasons. Also helping will be political
clarity out of Washington and Europe, and acceleration in durable
goods spending. Earnings are seen rising to $117 a share by
Capital goods spending, now at 21% of U.S. gross domestic
product, is at its lowest level since World War II, suggesting it
has plenty of room to expand before getting to lofty levels.
Corporate capital spending as a percentage of sales, currently
6.2%, is at the low end of its 16-year range of 5.1% to 8.1%.
The wealth effect from rising home values has lifted consumer
confidence but overall debt levels remain high, while wages and
incomes are barely growing in the face of relatively high
unemployment, according to Baird.
Returns each of the four years of the current bull market
followed the script of previous bull markets. If this pattern
continues in 2013, the S&P should rise only about 8%, its
historical average in the fifth year of bull markets, according
to Randy Frederick, managing director of active trading and
derivatives at Charles Schwab.
"The first year of a presidential term has been positive only
eight of the last 15 times with an average return of 4.7%,"
Frederick wrote in a report. "Should (2013) follow this
presidential pattern and the fifth-year cycle pattern, a return
of somewhere between 5% and 8% seems likely for 2013."
Retail Investors Miss Out
Fund flow data shows investors favored the safety of bonds,
despite record low interest rates, and shunned equities even
though U.S. and foreign stock markets posted double-digit gains.
Inflow into fixed-income mutual funds and
shot up 115% in 2012 to $364 billion, according to TrimTabs
Investment Research estimates. That's while equity funds saw
outflow of $20 billion, following $68 billion in outflows in
Investors are rushing for safety although real Treasury yields
are negative when adjusted for inflation.
"Unless Treasuries are held to maturity, their being
'risk-free' is a myth," Baird's strategist wrote in the firm's
2013 Economic & Stock Market Outlook. "A 10-year Treasury
note purchased in 2012 could see a significant decline in
principal value five years from now even if interest rates rise
Fears of tax-loss selling appear overblown considering that
investors funneled $7 billion into equity funds in December after
pulling out $7 billion in November, said David Santschi,
executive vice president at TrimTabs.
BofA Merrill's research found that higher dividend tax rates
don't affect stock performance as much as earnings growth.
High-dividend payers actually performed worse after the dividend
tax rate was dropped to 15% following the Jobs and Growth Tax
Relief Reconciliation Act of 2003. Perhaps it's because more than
half of mutual fund assets are invested in tax-deferred or exempt
Sector Fund Performance
Funds investing in international real estate climbed a
whopping 40.75%, outpacing all sector funds. Funds investing in
precious metals and energy commodities lagged most, losing 9.36%
and 7.56%, respectively.
BofA Merrill recommends overweighting the most economically
sensitive, or cyclical, sectors heavy with foreign sales such as
technology, energy and industrials. It advises underweighting
overvalued, U.S.-focused sectors, utilities and telecom, on the
expectation that overseas economic growth will top that of the
"S&P 500 stocks most correlated with U.S. GDP growth are
currently trading at a discount to the benchmark, when they
typically trade at a about a 5% premium," BofA Merrill equity and
quant strategist Savita Subramanian and her colleagues wrote in a
2013 strategy report. "S&P 500 stocks with the highest
foreign sales exposure could outperform in 2013 amid the
improvement in global growth."