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  2. MARKETS
January 09, 2012 12:00 AM

Institutional investors are optimistic for the new year

Many predict rebound for S&P 500, though 1 says recession is likely

Barry B. Burr
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    Jin Lee/Bloomberg
    Falling: A. Gary Shilling sees a 'mild to moderate' recession for the U.S. economy.

    Many institutional investment strategists believe the S&P 500 generally will return more than 10% in 2012, even though they expect the U.S. economic growth rate to be slow and unemployment to remain high.

    At least one strategist sees a recession coming, while two others predict an increase up to 20% for the benchmark index.

    “Fundamentals will overtake fear” in 2012, predicted James W. Paulsen, chief investment strategist, Wells Capital Management Inc., Minneapolis. Mr. Paulsen sees a strong performance for U.S. equities, though “the irony is we could have a pretty bloody bond market.”

    A. Gary Shilling, president and economist of an eponymous economic consulting and investment advisory firm based in Springfield, N.J., forecasts a “mild to moderate” U.S. recession for the year. He is bearish on stock and bullish on Treasury bonds.

    Globally, the strategists were generally optimistic about Asia and emerging markets equities, but see Europe's prospects as weak.

    S&P 500 forecast

    In other forecasts for the Standard & Poor's 500 for this year:



    • Mr. Paulsen sees an S&P 500 total return, including dividends reinvested, “in the high teens to 20%. I think it will be a pretty good year. We really brought valuation down quite a bit” in 2011. He expects the index to end the year “in the upper 1,400s, maybe 1,475.”

    • Dan Morris, global strategist at J.P. Morgan Asset Management, London: “I probably am looking for a 10% gain or so for the index. So let's say a year-end target for 2012 of 1,400 for the price index, a little over 10% on price return ... so maybe a 13% to 14% total return. ... I think people are overly pessimistic (about the U.S. market) so I think that's the opportunity” for investors.

    • Milton Ezrati, partner, senior economist and market strategist, Lord Abbett & Co., Jersey City, N.J.: “There's a lot to worry about. The balance of probability is the market should be up between 10% and 20%” on a total return basis.

    • Joshua N. Feinman, chief economist and member of the global asset allocation team at Deutsche Asset Management, New York: The S&P 500 total return will be up only 5% to 10%.

    • Brett Hammond, senior economist, TIAA-CREF, New York: “Long-term S&P 500 gains are in the high single digits. It wouldn't surprise me if we were in that range” in 2012. “What we say is overoptimism shouldn't be in order when it comes to the S&P 500 or other (equity) market returns. We think that the forces that are underlying all this are really pointing in the direction of a modest expectation.”

    The impact of politics

    Mr. Shilling is alone in forecasting a negative S&P 500 return. He sees the price level falling 25%, making for a total return plunge of 23%.

    David J. Kostin, chief U.S. equity strategist, and four other Goldman Sachs Group Inc. analysts in a portfolio research report predicted the S&P 500 will finish 2012 “unchanged for the second consecutive year at roughly 1,250.”

    The S&P 500 finished 2011 at 1,257.6, up 2.1% on a total return basis.

    The 2012 presidential election won't have much of an impact on investment performance, analysts said. “The S&P 500 tends to do pretty well in an election year, going back to 1928 ... above historical averages,” Mr. Hammond said. “It's a tendency. ... It didn't do so well in 2000 and 2008.”

    The economy does better in a presidential election year where there's been economic stimulus in the third and fourth year of a presidential term, Mr. Hammond said. “What happened this time around (is) the stimulus came earlier for good reasons because the economy was in terrible shape. ... We are unlikely to get that same kind of stimulus this year.”

    For global equity markets, Mr. Paulsen expects the U.S. stock market to outperform developed markets, although the dollar will generally come down against the euro and other currencies, which will help international investments on repatriation. “Emerging markets will outperform everything,” he added.

    Messrs. Ezrati and Morris agreed that emerging markets stocks will do better than U.S. equity, while European stocks will have a rough go, with returns ranging from flat to 5%.

    “Europe (is) in pretty sad shape,” Mr. Hammond said. “The expectation for most of Europe is that they are still going be struggling” for the year. “Asia is poised to do better. ... Emerging markets have been beat up, so I think there are some good opportunities.”

    Fixed-income forecast

    For fixed income, most strategists believe Treasury returns will plunge as the economy strengthens and investors take on more risk and move away from the safe haven.

    “If confidence improves for investors, I think you could have a 3.5% (10-year) Treasury rate quickly,” which would damage valuation, Mr. Paulsen said. Investors “will look at equities as more of a bargain than a risk, and see bond yields as (unattractive) low yields rather than as a safe haven. ... The best friend of the 10-year Treasury bond has been fear,” pushing yields down. Also, Mr. Paulsen said, “I think there is a pretty severe risk for high-quality bondholders” for similar reasons as confidence buoys.

    Treasury bond rates will go up, said Mr. Ezrati. The economy will continue to grow and the European situation, although it won't go away, will be less intense in 2012, “so this flight to quality that has driven everyone into Treasuries will begin to reverse.”

    The 10-year Treasury rate — 2.02% as of the Jan. 5 close, up from 1.89% at Dec. 30's close — “could easily rise to as much as 3%” in 2012, Mr. Ezrati said. Such a move “would destroy any return anyone had in that instrument.”

    Mr. Ezrati said high-grade corporate bonds will also be hit. “The highest-grade corporate bonds have enjoyed the same interest (attraction) that people have had in Treasuries as a safe haven. They (corporate bonds) should not do to as well as” lower-rated bonds.

    “Lesser-grade credits, whether it is junk bonds or intermediate-grade credit quality corporate bonds, should do very well,” Mr. Ezrati added, because investors will be willing to take more risk of rising economic prospects. “They should pay at least the yield. So with junk bonds yielding 7% or 8% or even more, they should give you at least that much” return.

    Mr. Morris looks for a 10-year Treasury rate of 2.5% to 3%, while Mr. Shilling foresees a bull market in Treasury bonds and thinks the 30-year Treasury bond yield, at 3.06% as of the Jan. 5 close, will fall to 2.5%. “That's where we got at the end of 2008 after the Lehman collapse,” Mr. Shilling said. The 10-year Treasury rate will fall to 1.5%, he said.

    For overall investment, Mr. Paulsen favors emerging markets and U.S. equities, especially small caps and large industrial, material and financial companies.

    Mr. Ezrati sees stocks as the best-performing asset class in the U.S. “I think investors should avoid Treasury and agency bonds and they should buy low-grade credits,” such as junk bonds and intermediate-grade correlate credit.

    “Right now may be an especially good time to become a contrarian,” said Mr. Hammond. “The markets have been so choppy, it's basically all volatility all the time and in the equity markets it's hard to find a trend. So maybe the contrarian thing these days is to take a longer-term view.”

    Stocks are attractive “if you think there are things like mean reversion or laying the groundwork for better economic growth,” Mr. Hammond said. “Bonds have had a spectacular 10 years,” but “the long-term growth prospects for bonds maybe they aren't as good as the last 10 years.”

    He also suggested long-term investments. “We have been very interested in ... natural resources, buying the natural resources themselves,” not commodity futures, such as farmland and oil and gas, Mr. Hammond said.

    Mr. Morris cast his lot for higher-yield debt over equities, “because if you look at high-yield debt, it is 720 basis points over Treasuries now for a 9% yield. The low default rates on high yield are going to go up a little but we don't think a lot. If you have got GDP growth of 2% to 2.5%, you're not going to have a big increase in default rates ... so you are getting paid for default risk several times more” than it needs to be.

    Emerging markets debt forecast

    Mr. Morris also likes emerging markets debt, which he said “looks very attractive for the risk” at a 7% yield.

    The challenge for U.S. equity still is going to be risk aversion, he added. “It comes down to earnings ultimately for equities. Earnings growth in the U.S. in the (2011) third quarter was 20% year over year. ... I think companies will be hard to sustain that.”

    The worst performing asset class, Mr. Morris believes, will be core sovereign debt. He's also “a little nervous about gold, even though it has come down quite a bit (in price), I think gold is probably unsustainably high.” Gold closed at $1,563.70 Dec. 30.

    “The huge amount of risk aversion is compressing those yields” on sovereign debt, Mr. Morris added. “As that goes away, things are going to normalize” and “rates will go higher. I think core debt is probably the most at-risk” asset class.

    Mr. Shilling said the best asset classes are Treasuries and the dollar. “I think real estate ... and stocks are vulnerable” as well as junk bonds, developing markets stocks and bonds and commodities. A recession will hurt junk bonds, Mr. Shilling said. “A lot of them have (already) refinanced, so you have a cushion, but if you get a serious recession, their revenue and ability to service their debt is in trouble and you probably will see some increase in defaults.” In “this zeal for yield, obsession people were throwing money at junk bonds.”

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