Investment outlook for 2013 clouded by uncertainty

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Usually by early December, investment professionals have mapped out their outlook for the next year.

But such forecasting has been made difficult by the "fiscal cliff" — the confluence of spending cuts and higher taxes that kick in automatically next year if politicians in Washington can't reach a deal.

Some experts are waiting for the dust to settle on a compromise before outlining a 2013 investment strategy.

But others say if it isn't the fiscal cliff, it would be the debt ceiling or some other Washington-manufactured crisis to worry investors. They recommend that investors look past the immediate policy crisis and think long term. After all, they say, most investors are saving for college or retirement — goals that are many years off.

"There is life after the fiscal cliff," said Craig Fehr, an investment strategist with Edward Jones in St. Louis.

Even with all the uncertainty now, some experts feel comfortable making a few predictions for the new year. The economy, they say, will continue to grow at a modest annual rate of 2 percent to 2.5 percent. Interest rates will remain low, a challenge for savers and bond investors.

The U.S. stock market will post a gain, but not as much as this year. The S&P 500 index, a broad measure of market performance, is up nearly 12 percent this year. The market will go up by 6 percent to 10 percent, forecasters say.

And no matter what kind of resolution Congress and the White House reach on the fiscal cliff, higher taxes and lower government spending next year are a safe bet.

"The debate in Washington now is what magnitude and who gets hit," said Wayne Lin, portfolio manager with Legg Mason Global Asset Allocation in New York.

Here are other observations for the 2013 outlook:

U.S. stocks

Several signs bode well for the stock market here.

"A lot of corporations are loaded with cash. They have not spent it. They have not hired new workers," said Jerry Scheinker, an executive vice president with Janney Montgomery Scott's Baltimore office. "The economic numbers are better. The housing numbers are better. Clients are finally more positive about investments, instead of keeping money in CDs and Treasury bills and bank accounts."

Chicago-based Morningstar tracks 1,500 stocks, mostly in North America. Under a formula that takes into account future cash flow and current stock prices, Morningstar concludes that the median stock going into 2013 is mildly undervalued. In other words, at least half the stocks are selling for less than they're worth.

Lin also leans toward U.S. stocks, rather than international equities. He noted that currency volatility puts investors at exchange-rate risk.

Some investment professionals recommend stock in companies that regularly increase their dividends, even though the tax rate on this income is set to go up next year.

"Over time, those are the best performers," Fehr said. "We don't think that track record changes because tax rates change."

Scheinker added that even if investors must pay more taxes on dividends, that's still better than earning meager interest on a certificate of deposit and paying taxes on that.

International equities

For the past couple of years, investors have been wise to stick with the U.S. stock market, which has shown more stability than markets elsewhere, said Rick Vollaro, chief investment strategist with Pinnacle Advisory Group in Columbia. But for 2013, he suggests that investors set their sights overseas.

"We've already dipped a toe in Europe," he said. His firm put money in exchange-traded funds that follow a European stock market index and one that tracks the Italian stock market, which is down by more than 70 percent since 2007 recession.

Europe is still digging out of its fiscal problems, but if the economies there merely stabilize, that would be good news for investors, he said.

Vollaro said his firm also is raising its position in emerging markets, particularly China.

"China is attractive compared to the United States," agreed Brenda Wenning, principal of Wenning Investments in Newton, Mass. China's stock market isn't even close to hitting its highs, she said.

Wenning acknowledged that some of the economic data coming out of China is mixed, but added that the country appears to be growing, particularly in trade and manufacturing.

"China is in a position to emerge as the world's largest trading giant," she said.

Technology

This is one sector that could shine next year, experts say. Businesses have been sitting on piles of cash for a long time, waiting for clarity on spending cuts and tax increases.

Once that happens, businesses can plan their spending and likely will make technology updates that they had been putting off, experts say.

Many tech companies, including Apple, Microsoft and IBM, are holding a lot of cash, said Doug Ober, CEO of Adams Express Co. and Petroleum & Resources Corp. in Baltimore. He expects some will buy back their own shares, thus increasing the value of stock held by their investors.

Energy

This sector looks undervalued, largely because of what's been going on with natural gas, said Paul Larson, chief equity strategist for Morningstar. The marketplace has been flooded with a supply of natural gas, thanks to discoveries of new sources and developments in drilling methods. The price of natural gas has fallen by about two-thirds in the past four years, he said.

Larson predicts that natural gas prices will return to normal levels in the next couple of years. Indirectly, that would benefit Chicago-based Exelon, which acquired Baltimore's Constellation Energy this year, Larson said.

Natural gas is used to generate electricity. And as gas prices go up, the cost of electricity will go up for consumers, and that will mean higher Exelon earnings, Larson said.

Health care

As the number of older Americans continues to rise, so does their use of health-related products and services. This should benefit a wide range of health-related businesses, such as hospitals, pharmacy management companies and drug makers, particularly those making less-expensive generics, Ober said.

Health insurers also will benefit from having millions of new customers when the Affordable Care Act takes full effect in 2014, he said.

But not all health care-related companies stand to gain as the United States grapples with the rising cost of health care. Hospitals that have many patients on Medicaid and Medicare, the government programs that pay for health care for the poor and elderly, could see their payments reduced through federal spending cuts, Ober said.

Bonds

"It's going to be boring" next year, said Dick O'Brien, a bond expert and senior executive vice president at Folger Nolan Fleming Douglas brokerage in Hunt Valley.

Federal Reserve policymakers plan to keep short-term interest rates low until employment and the economy pick up, so yields on bonds will remain low, he said.

"We will end next year very close to where we are presently," O'Brien predicted, "unfortunately for investors and savers."

O'Brien said some clients have been so disappointed in bond yields that he recommended high-grade common stocks that pay dividends, such as Microsoft, ExxonMobil and Johnson & Johnson.

"This is heresy for a bond person," O'Brien said. But Microsoft's 10-year bond this month had a yield of about 2.2 percent, while the dividend yield on its common stock was 3.38 percent, he said.

Investors often consider bonds safer than stocks, but some experts warn against forgetting the big risk to bonds — rising interest rates. When rates rise, the price of bonds falls.

Fehr of Edward Jones said long-term rates — those affecting 15- to 30-year bonds — might begin to tick upward next year. That would be bad news for the many investors who purchased long-term bonds seeking higher yields.

"It's nearly impossible to project when interest rates will move and where they will go," Fehr said. But at this stage, he added, rates are more likely to go up than down.

eileen.ambrose@baltsun.com

twitter.com/eileenambrose

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