For U.S. equity investors, the next 12 months may be all about staying home.
For U.S. equity investors, the next 12 months may be all about staying home. After years of looking brightly on foreign markets and cajoling American investors to expand their international exposure, market strategists are now describing the domestic equity market as being “the best house in a bad neighborhood.”
According to the InvestmentNews 2012 Investment Outlook survey, 43.6% of advisers said they would increase their clients' allocation to U.S. stocks compared with just 18.7% who said they would increase allocations to foreign equities.
“In 2012, we see the U.S. economy as barely growing, but that will be better than the eurozone, and it will also be better than the emerging markets on a relative basis,” said George Feiger, chief executive of Contango Capital Advisors Inc., which has $3.3 billion under advisement.
“Right now, the U.S. is the least bad place to be,” he added. “You can see how U.S. stocks have been reacting to what's going on in Europe, but unlike Europe, our financial system is not insolvent.”
Mr. Feiger falls in line with most market watchers these days in forecasting weak returns for equities in the year ahead.
“I think our economy will continue to hobble along, because we're stuck in a channel,” he said. “The specific equity opportunities are going to be like islands in a swamp, with the swamp slowly draining and the islands gradually getting bigger.”
With that in mind, the global macro perspective does not bode well for broad-market buy-and-hold investing in 2012, according to Christian Hviid, managing principal at Point Guard Capital LLC.
“If you're willing to do some homework and take some risk, there will certainly be an argument for active management,” he said.
The unfolding crisis in Europe, which has the European Union scrambling to provide financial support for weaker eurozone nations, has become the new near-term backdrop for the global economy, Mr. Hviid said.
“I'm expecting many European Union member countries to head into recession, and that leads to a slowdown in the emerging markets,” he said. “But this all offers opportunities for long-term investors because a lot of babies are being thrown out with the bath water.”
In other words, even though Mr. Hviid sees more downside risk than upside potential in the equity markets over the next 12 months, he believes diligent stock pickers still will be able to find attractively valued companies.
Nigel Emmett, client portfolio manager at J.P. Morgan Asset Management, concurs that all the negative news out of Europe will create selective values on a stock-by-stock basis.
“As equity investors, we don't buy stocks based on macroeconomic headlines, because we're looking at the quality of corporate balance sheets,” said Mr. Emmett, who helps manage $25 billion as the head of the global equity team for North American clients.
He added that with the exception of financial sector stocks, most European corporate balance sheets are in better shape now than in 2007.
“Undoubtedly, we're going to have a recession in Europe, but many of the individual companies still have world-class global footprints,” Mr. Emmett said. “I'm not ignoring the macro story, but when you're looking at the kinds of companies that have been beaten down by the macro story, it creates opportunities for active stock pickers.”
David Marcus, chief executive and chief investment officer at Evermore Global Advisors LLC, said he currently favors the United States and Europe, despite the unfolding crisis.
“We factor in that things will be weak, but a lot of these companies have been sold off to levels that don't make sense,” he said. “Things are cheap because investors are freaking out, and, in a crisis, investors return home and invest locally. But a lot of the companies that have been sold off are giving you cheap exposure to places like the U.S., Asia and the emerging markets.”
Mr. Marcus acknowledged that the political and sovereign-debt issues facing several of the eurozone nations represent a major challenge for years to come, “but I think the companies are much smarter than the countries.”
The relative appeal of U.S. equities in 2012 extends a trend already in place.
Through mid-December, the flat performance of the S&P 500 for 2011 compared with an 18% collective decline by the European Union.
Over the same period, China and India were both down 25%, Hong Kong 20%, Brazil 17%, Japan 16%, Australia 12% and Mexico down 6%.
“The fact is, global growth figures are being ratcheted down and the effects of the European sovereign-debt crisis are playing a role,” said Jay Wong, head of equity strategy at Payden & Rygel Investment Management, a $60 billion asset management firm.
“Right now, valuations are attractive across the board, but if the European Union crisis continues, you will have to reassess those valuations,” he said. “In 2012, I'm expecting high-single-digit returns for equities in the U.S., and a lot of volatility. That's why we're recommending high-quality, high-dividend-paying stocks.”
The combined European economic region, with gross output of $12 trillion, represents the world's second-largest economy, behind the United States at $14.5 trillion.
Thus, until there is a more concrete resolution out of the eurozone, it is expected that a slowdown there will slow the pace of the faster-growing emerging markets such as China, India and Brazil.
“The bulk of the world's growth for the foreseeable future will ultimately come from the emerging markets, but the next 24 months will be ugly for everyone,” said Mr. Feiger. “It's not going to be the end of the Mayan calendar or anything like that, but it will be pretty grim, and that's why investors will have to be careful not to lose all their money in the next 24 months.”
This brings us back to the U.S. market, where companies are flush with cash, employee productivity levels are high, earnings growth is positive and valuations are attractive.
“Our view is, the U.S. market will remain the equity market of choice in 2012,” said Jim Russell, senior vice president of The Private Client Reserve of U.S. Bank, a unit of U.S. Bancorp, which manages $60 billion in investor assets.
“We are hoping for less [market] volatility and less confusing news flow [related to Europe], and we think the U.S. market will drift higher as the uncertainty decreases,” he said.
When the final numbers for 2011 are tallied, Mr. Russell expects the average earnings for the S&P 500 to be up 15% from 2010, but he's looking for a 2012 increase of between 6% and 8%.
“We know there will be a slowdown in growth,” he said.
But believing the central banks around the world are committed to introducing more pro-growth policies, Mr. Russell said cyclical sectors such as energy, materials, technology and consumer discretionary are the place to be.
A more cautious approach might be to stick with the defensive categories such as utilities, health care and consumer staples, according to Brian Gendreau, market strategist at Cetera Financial Group Inc.
Mr. Gendreau is not deviating from the belief that the economy will be sluggish in 2012, but he has found a silver lining.
“Stocks actually do surprisingly well in periods of slower growth,” he said, pointing out that broad-market equities produce average annualized gains of 9% during quarters when the economy is growing at less than 2.6%.
“Periods of slow growth mean things like slow wage growth, because nobody is asking for a raise right now,” he said. “So what you do is go into those stocks that tend to perform best in a slow economy — the defensive high-dividend payers.”
jbenjamin@investmentnews.com
