STOCKS & BONDS


Our Investing Outlook for 2013

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Now that we know that President Obama will be living in the White House for four more years, you can adjust your portfolio by doing -- nothing. Over the long haul, it's nearly impossible to tie a winning or losing market performance to a win for either party, says market analyst Jim Stack, of InvesTech Research.

But a nasty post-election selloff highlighted one gigantic caveat that comes with the benign outlook for stocks and for the economy overall: All bets are off if we get pushed off the fiscal cliff by uncompromising lawmakers in the nation's capital. The cliff refers to about $550 billion to $720 billion (depending on your accounting and what you include in the tally) in spending cuts and tax hikes slated to go into effect at the start of the year. If such extreme and sudden austerity were to occur, the U.S. economy would sink into recession and the stock market could fall 20% to 30%. Stocks sank 2.4% on the day after the election as investors concluded that ratification of the status quo would make it difficult for lawmakers to agree on a plan to avert the fiscal cliff.

Merrill Lynch economists think that after some messy wrangling, Congress will consent to $325 billion worth of spending cuts and tax hikes. That's enough to lop two percentage points off growth in gross domestic product, they fear, and, depending on the distribution between cuts and tax hikes, could whack the stocks of government contractors and luxury-goods makers. Food for thought: Uncle Sam accounts for 97% of sales at SAIC (symbol SAIC), an information-technology firm.

The fiscal cliff has already been a drag on the economy in the form of an uncertainty penalty, and a neck-and-neck election season didn't help. With so much fiscal, tax and regulatory policy up in the air, corporate boards tilted from cautious to almost paralyzed, letting cash pile up at S&P 500 companies to a $1.7 trillion hoard. Business spending on equipment and software likely grew just 7% in 2012, down from 11% in 2011, says IHS Global Insight. As a plan to resolve our fiscal issues starts to take shape, look for a rebound in economic activity, especially from pent-up corporate spending.

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But even the optimists aren't talking about gangbuster growth in 2013. A sluggish first half will combine with an accelerating second half to deliver gross domestic product growth of about 2% -- roughly the same rate as in 2012. Housing and vehicle sales will be bright spots, but growth in exports will disappoint, thanks to lingering weakness in Europe and slowing momentum in China. (See our outlook for international markets in Global Economy Back From the Brink.) With gasoline prices moderating and wage growth minimal, expect a 2% rise in consumer prices in the coming year, matching the expected 2012 inflation rate. Job growth will continue, pushing the unemployment rate down to 7.5%.

Frustrated savers are unlikely to see higher yields anytime soon. The Federal Reserve has said it will continue to do everything in its power to keep both long-term and short-term interest rates low while the economy remains fragile. Despite historically minuscule rates, income-focused investors can still find good deals in muni bonds and emerging-markets bonds in 2013, as well as in high-yield debt (see Outlook for Income Investors, 2013). But bond buyers should be mindful of the risks they're taking in the search for yield. When rates do finally rise, pushing prices down, the blow could be shocking to a whole generation of investors, says Edward Jones market strategist Kate Warne. "We are concerned that investors are underestimating interest-rate risk because they haven't experienced it in 30 years," she says.

Conversely, investors might be more afraid of stocks than they need to be, although given recent deterioration in the corporate earnings picture it's easy to see why people are spooked. The third quarter of 2012 was a dismal one, according to earnings tracker Thomson Reuters, which estimated that profits for S&P 500 companies fell 0.6% compared with the same period a year earlier. That's not much of a drop, but it would be the first decline in 11 quarters. And companies weighing in on prospects for the fourth quarter of 2012 were more pessimistic than they've been since 2001.

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