Take a good look at the impressive gains that both U.S. and global stock markets posted in 2011, to many investors’ pleasant surprise. You don’t want to miss the repeat performance in 2012.
The third time’s a charm, as the saying goes, and 2012 offers a trio of financial-market milestones. It’s the crucial third year of the so-called presidential cycle, the beginning of the third year of the bull market that started in March 2009 — all 10 bull markets since 1949 have celebrated their third birthdays — and, in June, the start of the third year of agonizingly slow but still positive U.S. economic growth.
“It’s going to be either a good year or a great year,” said Sam Stovall, the chief investment strategist at Standard & Poor’s Equity Research.
That said, investors should never expect smooth sailing, especially now with so much doubt and disbelief surrounding the economic courses being set in Washington and Europe.
S&P’s Global Investment Policy Committee cautioned in a recent report that “the very strong performances that are typically experienced” in U.S. markets during these third years “will likely be moderated by the aging of this bull market and the sluggishness of this economic recovery.” The group’s latest forecast puts the Standard & Poor’s 500 Index ($INX) at 1,315 a year from now, less than 6% higher than its close of 1,244 on Dec. 17.
Before looking in depth at what 2012 could deliver, how did our recommendations for 2011 fare? Solidly. In a bullish year for stock and bond investors overall, most of the picks made in January 2011 stood out. (Read “10 money-making investment ideas for 2010.”)
Advice to buy large-cap U.S. stocks with a global footprint paid off. A basic S&P 500 index fund would have done the job, posting an average gain of 13% through Dec. 16, according to fund-tracker Lipper. The index’s components earn almost half of their revenues overseas.
Using stock dividends as bond substitutes was a lucrative tactic. For example, equity-income mutual funds, which tend to focus on dividend-paying stocks, averaged a 13.7% gain last year, Lipper reports. Steering away from long-term Treasurys also was on target.
Owning cyclical technology-, energy- and industrial-sector stocks was a good call. The S&P 500 industrials sector was up 23% in 2011 through Dec. 16, with the average industrials-sector mutual fund gaining almost 26%. Meanwhile, the technology sector rose 9%, but many tech-focused mutual funds did much better, up 20% on average for the year. The S&P 500 energy sector rose 14%, in line with the average energy-stock fund.
Two tips you probably could have done without: An emphasis on large-cap stocks, which were steamrolled by small- and midcap rivals, and a bullish call on the U.S. dollar — its exchange-traded proxy, PowerShares DB US Dollar Index Bullish (UUP), is finishing a highly volatile 2011 basically flat. Still, it beat a bet on the euro.
As signs point to investors taking more risk and moving back into stocks, the tea leaves for 2012 suggest that bulls will have more room to run, especially those in U.S. cyclicals. Plus, while small- and midcap stocks have strong support, large-caps could enjoy a larger share of the spotlight. As always, buyers will have to tread carefully, particularly bond investors.
Against this multihued backdrop, here are 10 ways to position your portfolio through 2012:
The presidential cycle is a four-year U.S. stock-market pattern with surprising consistency, regardless of the president or the party in office. Next year is the cycle’s crucial third year, following the midterm U.S. elections but before the general elections, which bodes well for the broad market.
Historically, the third year — particularly its first six months — has been the cycle’s best, with the S&P 500 gaining 17% on average in that year of each president’s term since 1945, according to S&P. The top sectors in the third year since 1970 have been cyclical — chiefly technology, materials, industrials and consumer discretionary.
“We have never had the market decline in the third year since World War II,” Stovall said. “The party in power wants to stay in power, so they stoke the engines of the economy in Year 3, which bears fruit by Year 4.”
Economically sensitive companies were the U.S. market’s strongest in 2010, and their momentum will likely continue. These businesses shine in the earlier stages of an economic expansion as corporate and infrastructure spending increases.
“The global economy continues to recover, and what leads the world economy are emerging markets and business spending,” said David Bianco, the chief U.S. equity strategist at Bank of America Merrill Lynch, who sees the S&P 500 at 1,400 by the end of 2011.
That bodes well for the industrials sector — including firms involved with construction, engineering, railroads, air freight and logistics, electrical equipment, and machinery. Many U.S. industrial companies are multinational and so benefit from emerging markets’ growth.
One of Bianco’s five favorite stocks for 2011 is United Technologies (UTX, news), a global titan with units ranging from Sikorsky helicopters and Pratt & Whitney jet engines to Otis elevators. “It’s a conglomerate without weak spots,” Bianco said.
Sector investors can count United Technologies, along with General Electric (GE, news), Caterpillar (CAT, news) and United Parcel Service (UPS, news) as mainstays of exchange-traded funds iShares Dow Jones US Industrial Sector Index Fund (IYJ) and Industrial Select Sector SPDR (XLI), to name two index-tracking options.
Materials stocks, focused around chemicals, industrial gases, fertilizer, containers and paper products, are tied to commodity prices and, by extension, growth in emerging markets.
Accordingly, materials companies based in the U.S. are exposed to the fastest-developing areas of the world, and to sharp downside risk should commodity prices tumble. Strong demand from developing countries, coupled with the improved financial health of developed economies and rising global stock markets, should underpin oil, metals and other commodity prices, according to Moody’s Analytics.
Bianco’s work favors what he calls “big international growth stocks,” and in the materials sector that points to DuPont (DD, news) and Praxair (PX, news). The Merrill analyst also recommends Bemis (BMS, news) and Owens-Illinois (OI, news) in the container and packaging area.
Expectations for the technology sector are highly favorable, with 80% of money managers bullish on the business, according to a recent Russell Investments survey.
While some might see that as a screaming “sell” signal, global business investment in computer, software and communications equipment is higher, and consumers’ love affair with tech gadgets continues unabated.
Overall, the tech sector, with its large percentage of foreign sales, is enjoying record profit margins and positive analyst earnings revisions. Buying the “Tech Titans” is one of Bank of America Merrill Lynch’s key investment ideas for 2011, with International Business Machines (IBM, news) and Google (GOOG, news) serving as poster children for the theme.
Not incidentally, tech has been the best-performing sector in the third year of the presidential cycle, up 21% on average since 1970.
“Technology stocks are probably more undervalued now than they’ve been in years,” said financial adviser Kurt Brouwer, the chairman of Brouwer & Janachowski in Tiburon, Calif.
It’s worth noting that small-cap tech stocks could top their large-cap counterparts in 2011, according to Steven DeSanctis, a Bank of America Merrill Lynch small-cap strategist. Many of these issues boast solid growth, foreign earnings and quality balance sheets, which makes them attractive takeover plays, he notes. His favorites include Cadence Design Systems (CDNS, news), TriQuint Semiconductor (TQNT, news) and RF Micro Devices (RFMD, news).
Global growth favors oil and natural-gas companies, especially large-cap multinationals that pay dividends and are buying back shares.
Analysts at Ned Davis Research recently upgraded energy stocks, as did Richard Bernstein, the CEO of Richard Bernstein Advisors, who also likes materials stocks. Said Bernstein: “If the economy is indeed beginning to enter the midphase of the cycle, then energy and materials stocks begin to take leadership positions. We expect both global sectors to outperform in 2011.”
“We’re seeing a very favorable environment for energy,” added Ed Maran, a co-manager of Thornburg Value Fund (TVAFX), which has almost 20% of its portfolio invested in the sector. Top holdings include oil-equipment and services firms Baker Hughes Incorporated (BHI, news) and integrated oil companies Marathon Oil (MRO, news) and ConocoPhillips (COP, news).
Consumer discretionary stocks were top winners in 2010 and should ride the cyclical momentum next year. But it’s important to have some exposure to defensive stocks in case leadership changes.
Consumer staples are well-placed in that role, repeating the dominant investment theme of quality earnings, dividend growth and global representation. Sector leaders that Bank of America Merrill Lynch analysts favor include Avon Products (AVP, news), Kimberly-Clark (KMB, news), Procter & Gamble (PG, news), Coca-Cola (KO, news), PepsiCo (PEP, news) and Kraft Foods (KFT, news).
Moreover, consumer-staples giants benefit from the growing purchasing power of emerging-market consumers, but that’s a long-term trend. For 2011, U.S. consumers may be key to these companies’ growth.
“U.S. employment will be stronger than most investors expect next year, which could produce positive surprises for U.S. consumer stocks,” noted Bernstein, the investment strategist, in a research report.
Growth stocks, especially small caps and midcaps, outperformed value strategies in 2010 — and they should again in 2011. The largest of these companies feature broad global exposure and trade at a discount to their earnings growth rates.
“Growth looks cheap,” analysts at Deutsche Bank wrote in a recent research report, which singled out larger companies as the most appealing growth stocks.
Large caps, which are seen as more secure holdings, also tend to appeal to wary investors as bull markets enter their third year and grow long in the tooth (the average life span of a bull market since 1932 is 45 months, according to S&P).
“Large caps are trading at too large a discount to small caps,” the Deutsche Bank analysts said, “and will benefit from a reallocation back to equities.”
Developing countries are building a bridge to the future, with more than $6 trillion expected to be invested in infrastructure projects in the next few years. China alone could spend upward of $4 trillion on infrastructure as it embarks on its latest five-year plan, slated to run through 2015.
The goal of emerging nations is to create societies of comfortable middle-class consumers, but first those people need roads, bridges, houses, electricity and other modern conveniences.
The theme favors U.S., European and Japanese industrials, materials and energy stocks. These companies have the experience and know-how to handle projects related to energy and power, transportation and logistics, and water and the environment. (Read “How to invest in three hot emerging-markets sectors.”)
The “Dogs of the Dow” are the 10 highest-yielding Dow stocks, and buying them at the start of the year and holding for 12 months (and one day, for tax reasons) has been profitable over the years. The Dogs were up 13% for 2010 through Dec. 15, while the Dow Jones Industrial Average rose 9.4%.
The Dogs typically have been well-known large-cap value stocks that have fallen out of favor, but nowadays many traditional large-cap growth shares are priced at compelling discounts to their growth rates — and thus offer a winning combination of predictable earnings and consistent dividends.
“With reasonable price-earnings ratios and decent dividends, selected high quality stocks look to be attractively-priced for patient, long-term investors,” wrote Brouwer, the financial adviser, on his blog Fundmastery.
The Dogs for 2011 are: AT&T (T, news), Verizon Communications (VZ, news), Pfizer (PFE, news), Merck (MRK, news), Kraft Foods, Johnson & Johnson (JNJ, news), DuPont, Chevron (CVX, news), McDonald’s (MCD, news) and Intel (INTC, news).
After two years of stunning gains, bond investors are taking stock of their portfolios. Yield is still scarce, but the risk of owning Treasurys, foreign government bonds and U.S. municipal debt is greater — especially for longer-dated issues that are highly sensitive to interest-rate swings. Bond prices move inversely to yield.
Accordingly, income-seeking investors will have to get creative. In addition to using dividend-paying stocks as bond substitutes, consider both high-yield and high-quality corporate debt, and stay with short-term and intermediate-term bonds and bond funds, which are better insulated from rising interest rates.
Master Limited Partnerships are also worth considering. Shares of these tax-advantaged income generators — an energy-heavy sector consisting largely of pipeline operators — soared in 2010, with a corresponding decline in yields.
Yet for income-oriented investors, “MLPs remain one of the more attractive opportunities in the market, offering high yields backed by stable and growing cash flows,” noted Jason Stevens, an analyst at investment researcher Morningstar, in a recent report. He singled out Enterprise Products Partners (EPD, news), Plains All American Pipeline (PAA, news) and Boardwalk Pipeline Partners (BWP, news) among several MLPs to watch.
Bond buyers, meanwhile, will be watching out for an eventual rise in interest rates. Investment strategist Bernstein said he can see longer-term Treasurys yielding 1.5 percentage points more by the end of 2011, which would hit those bonds hard.
“The (bond) landscape has changed,” added Marilyn Cohen, head of Envision Capital Management, a bond-investing specialist in Los Angeles. “We’re in for a bear market. Baby boomers have never lived through a bear market in bonds with their money in the market. They’re going to get sideswiped.”