Call it the bull market that everyone loves to hate. dissed by professionals and deserted by individual investors, the U.S. stock market climbed the proverbial wall of worry in 2012, despite a climate of economic unrest and enough political uncertainty to give any sane investor pause. “Bleak is the new black,” quips Larry Hughes, chief executive of BNY Mellon Wealth Management, who says he’s never seen market sentiment so negative.
And yet, stocks have beaten -- by far -- asset classes more beloved by investors. Over the past year through November 7 -- the period since we published our last annual outlook story -- Standard & Poor's 500-stock index returned 13.2%. The U.S. bond market returned 4.8%, and cash pretty much earned nothing. Now, with the economy still sputtering, corporate earnings faltering and sales at many companies sinking, it's fair to ask: Can the stealth rally continue? Or will the stock market finally succumb to its poor reputation in 2013?
We think investors should hold their noses and stick with stocks. Patient investors can pick up bargains during periods of weakness -- of which there could be plenty in early 2013, when things will likely be messy in Washington and on Wall Street. But with economic disaster averted overseas, and as the clouds of fiscal uncertainty at home begin to part later in the year, we think that corporate profits can continue to grow modestly on the back of good-enough economic growth. Cash-rich companies that can manufacture growth in a tepid economy will deliver the goods to shareholders.
Bottom line: The market has a good chance of posting gains of 7% over the coming year, with dividends kicking in another two percentage points. That would take the S&P 500 to 1492, while an equivalent gain in the Dow Jones industrial average would take it to 13,838. The S&P and Dow closed at 1395 and 12,933, respectively, on November 7.
As we look toward the new year, it's rare -- and ironic -- that stocks are so disrespected. Investors yanked money out of stock mutual funds and poured it into bond funds throughout 2012. And the so-called smart money doesn't like the market any better. Wall Street strategists haven't been this bearish since Bank of America Merrill Lynch started keeping track in 1985. "Equities are as hated as they've ever been," says Savita Subramanian, Merrill Lynch's chief stock strategist. That suggests, she says, that people are underinvested in stocks and that they've overdone it in bonds. "When investors get their statements for the year and see single-digit gains in bonds and double the returns in stocks, they'll come back to the market."
Despite a rally that has seen the market more than double from its bear-market low in 2009, stocks still represent good value, says Brian Belski, chief investment strategist at BMO Capital Markets. At this stage in bull-market rallies going back to 1970, the S&P 500 is typically 14% higher than its previous peak, he says. But the index recently traded more than 10% below its 2007 high.
Stocks in most market sectors, including consumer staples (companies that make the things we use every day, such as soap and cereal), energy, health care and technology, are trading below their long-term average price-earnings ratios. At the same time, the companies are sporting profit margins and cash levels above their historical norms. Only utilities and telecommunications stocks are trading at above-average P/Es. Belski's bullish conclusion: "We expect the market to hit new highs sometime during 2013."