Reduce to one word the primary investment theme among investment strategists for 2011, and it would be equities.
“We've had investors trying to invest on what the next crisis is going to be” and staying away from equities and other risk assets, said James W. Paulsen, chief investment strategist, Wells Capital Management, Minneapolis.
“But suddenly, if it looks like recovery might last a few years, then ... risky assets, equities, look more attractive.”
Institutional investor anxiety about recession is easing, with the consensus changing toward a view of a sustainable recovery, albeit a weak economy, Mr. Paulsen said. “That's why you are seeing (upward) changes in valuations in the stock market,” he added.
Forecasts vary among strategists.
• All predict a rising gross domestic product, ranging from a slow 2% growth to as much as 3.5%.
• Predications for the S&P 500 range from flat to a 15% return.
• The inflation rate, based on the Consumer Price Index, could range from a deflationary -3% to a modest rise of about 2%.
The Standard & Poor's 500 stock index will reach 1,425 sometime in 2011 and achieve possibly a 15% total return, Mr. Paulsen predicts.
In Barclays Capital Inc.'s Global Macro Survey of 2,007 responding institutional investors, including equity, fixed-income and hedge fund managers, 40% of respondents ranked equities as the asset class that will perform best in 2011. Commodities followed at 34%, corporate and other credit fixed income at 10%, high-quality government bonds at 9% and minor European government bonds, 7%.
For the U.S. market, the Barclays macro survey, released Dec. 14, showed 55% of respondents believe the most likely outcome for next year is a sustained period of upward, but below normal, growth in the economy without a need for further monetary policy easing, while only 6% believe a double-dip recession will occur. Some 31% see below-trend growth leading to further Federal Reserve easing, while 8% see a pickup in demand leading to sustainable growth.
Macroeconomic growth ranked as the top bullish factor for U.S. equities, cited by 26% of investors, more than twice as many as any other single factor. Only 12% believe equities will underperform.
Barclays Capital, however, is more optimistic for 2011 than the majority of investors in its survey, said Piero Ghezzi, London-based head of economics, emerging markets and foreign exchange research. For next year, Barclays Capital sees U.S. real GDP growth, adjusted for inflation, of between 3% and 3.5%. The majority of investors foresee a 2.25% U.S. real GDP growth.
“Our sense is investors have been hurt by overweighting risk to growth,” Mr. Ghezzi said.
The Barclays Capital Global Outlook report, released Dec. 9, predicts a 2011 S&P 500 level at 1,420, about a 15% gain for the year.
Developed and emerging
Equities in both developed and emerging markets are likely to outperform because of a combination of stronger economic growth and monetary and fiscal policies globally favorable to investors, Mr. Ghezzi said.
U.S. equities look particularly cheap compared with other developed markets, Mr. Ghezzi said. Emerging markets will probably outperform U.S. markets because of their higher beta. The U.S. probably will do better than Japan and Europe, Mr. Ghezzi added.
“We do not remember a time when growth was so strong and (monetary and fiscal) policy so easy. Monetary policy is easy and loose everywhere (globally),” but fiscal policy depends on the country, Mr. Ghezzi said. The U.S. is easy but Germany is tight.
The Barclays report predicts U.S. inflation going from 2.4% in the first quarter of 2011 to 1.1%. by the last quarter.
David J. Kostin, New York-based managing director and U.S. investment strategist in global investment research at Goldman Sachs Group (GS) Inc., and three research colleagues predict investors will direct a combined $750 billion into U.S. stocks in 2011, equivalent to 7% of the S&P 500's market capitalization, a surge based on optimism in the sustainability of the recovery and moves out of low-returning less-risky assets.
Retirement funds, mostly defined contribution funds, will invest $125 billion of that total inflow. Their part will come from both contributions and reallocation of existing assets, Mr. Kostin and the others said in a report, released Dec. 2, “U.S. equity outlook: Easy money, hard market.”
“We believe investors will move up the risk curve into equities, given low yields (on other investments) and increasing evidence of a firming economy,” they said in the report.
“From a relative value perspective, the S&P 500 has looked cheap relative to both Treasury and corporate bonds for most of the past two years,” they added in the report.
The S&P 500 will reach 1,450 at year-end 2011, for a 23% total return for the year, the Goldman Sachs analysts predicted.
Goldman Sachs economists forecast for next year real GDP growth at 2.7% and inflation at less than 1%, the Goldman Sachs report noted.
Wells Capital's Mr. Paulsen noted such a bullish outcome would produce the third year in a row of double-digit returns on the S&P 500.
“Most of it has occurred at a time people were told to stay out of risky assets,” Mr. Paulsen said.
But not all institutional investors are sanguine about equities.
Ashbel C. Williams Jr., executive director and chief investment officer of the Florida State Board of Administration, Tallahassee, which oversees $147.6 billion, favors a neutral weighting for equities at best.
“I wouldn't want to be significantly underweighted,” Mr. Williams said. “But I'd be happy to be fully weighted at target.”
He believes the best-performing asset classes next year will be private equity, opportunistic real estate and specialty fixed income, such as distressed credit.
Pessimistic about stocks
A. Gary Shilling, president, A. Gary Shilling & Co., Springfield, N.J., an investment advisory and economic consulting firm, predicts 2% GDP growth and inflation that is low or even a deflationary -2% or -3%. He is pessimistic about stocks.
“I think stocks are fully priced and then some,” Mr. Shilling said. “I think maybe (there will be) some downside.”
“The risk is that the economy doesn't hold up,” Mr. Shilling said. “If you look at it sector by sector, it's hard to see what will be strong (in 2011). Consumers look like they are trying to save money and pay down debt. The housing sector is overburdened with inventory. I'm looking for another 20% decline in housing prices (next year), mainly because of the excess inventory.”
Mr. Shilling ranks fixed income as possibly the best asset class for performance next year and would overweight it.
“Interest rates will be going down,” he said. “With a weak economy and possible deflation, and problems in Europe and China, (that) makes the dollar and Treasury a safe haven.”
For next year, he sees a 3% rate of 30-year Treasury bonds, 2% on 10-year securities, while shorter-term rates will stay close to zero.
He likes long-term Treasuries for next year.
“I've been a fan of 30-year Treasuries,” Mr. Shilling said. “They got beat up recently, but they are still attractive. If they go from 4% to 3%, you make a 25% appreciation.”
“I don't buy Treasuries for yield but price appreciation,” Mr. Shilling said.
In real estate, there is excess capacity in office and hotel space because businesses aren't hiring and people have curtailed traveling, he said.
But two real estate areas he believes are attractive are rental apartments, as individuals move away from houses because of their concern about investment value, and medical office buildings, as the new health-care law and aging baby boomers raise demand for health care.
Mr. Shilling said he is not keen on private equity and venture capital because their value is ultimately linked to the public equity market.
Hedge funds will be challenged trying to find niches to exploit, he added.
Overall for the economy, Mr. Shilling said, “I don't know if there will be double-dip (recession). But there is another recession out there; they aren't extinct. Whether they will call it a separate recession or a double dip, there is another one out there, maybe in 2012.”