2013 Investment Landscape

Six scenic overviews for wise investments … unless we tumble over the fiscal cliff.

Despite some well-publicized cliffs that could undermine the economy, local wealth management executives are pretty bullish on the 2013 stock market. These are not people who look at the world through rose-colored glasses, but professionals who take a broad look at what’s unfolding in the national and global economies and see opportunities.

Our panel of experts predicts stock market growth ranging from 5% to 7% on the conservative side (Triumph Wealth Management and RBC Wealth Management), and up to 10.3% on the high side (Thompson Investment Management), but much is predicated on avoiding the so-called fiscal cliff. 

Jason Stephens, COO and portfolio manager for Thompson Investment Management, cited steady improvement in housing and consumers’ ability to deal with credit – the deleveraging of individuals. “If you look at debt-service levels as a percentage of disposable income, we’ve seen a steady decline over the past three or four years,” he said. “As data points like that continue to come through, there is a lot more confidence in the projections we’re seeing.”

Laurie Binius Droster, senior vice president for RBC Wealth Management, mentioned a few worries that could negatively impact 2013: the “fiscal cliff” of tax rate increases and automatic spending cuts that could cause a recession; another pending decision about whether to raise the debt ceiling; and employment living up to its reputation as a lagging economic indicator.

“Until everybody is back working again, there won’t be a huge boost in gross domestic product,” Droster stated. “With the fiscal cliff, we could see as much as a 4% hit to GDP, which would put us in a recession because GDP growth is only about 1% to 2% right now.” 

However, the potential calamities are avoidable, and the positives are encouraging. Droster noted the economy is showing signs of getting out of first gear, with manufacturing strength, a healthy increase in housing starts, and improvement in home prices nationally. 

But due to lingering uncertainty, it might take some time for the market to gain traction in the new year. “Our analysts think that at the beginning of the year, the overall economy is going to take a little bit of a hit, but the second, third, and fourth quarters will pick up a little,” Droster said.

Nathan Brinkman, president of Triumph Wealth Management, is another optimist, but he knows the fiscal cliff and the European debt crisis and recession could undermine the U.S. economy. “I’m generally optimistic, assuming our friends in Washington will kick the can down the road in terms of the Bush-era tax cuts,” he said. “That said, we all know about the risks that exist in terms of the conflicts in the Middle East, what happens with Greece, and things like that.”

In addition, failing to extend the debt ceiling next year, which must be done sometime in the mid-February to early-March timeframe, would have market repercussions. “If they do not do some extension, the market is going to punish them,” Brinkman said. “With the debt ceiling last time, Washington didn’t make a decision, and the markets went down.”

In this look at the 2013 investment climate, we do not offer specific stock tips, but six mile markers to guide your investment journey.

Marker 1: Inflation Offramp

During the recession and the slow-growth economy that followed, the Federal Reserve stepped on the gas. Two episodes of quantitative easing and, more recently, a program of asset purchasing have some worried that Fed Chairman Ben Bernanke will unleash inflation. 

Others have poured cold water on that concern, noting the Fed is not actually monetizing the debt, which would be inflationary, and our investment experts agree. High inflation, which would have to be tamed by raising interest rates, is not a concern for 2013.

“Inflation is probably too low right now,” Stephens said. “You want 3% inflation. The concern is what happens if you get to 5%, 6%, or 7% inflation, or the [double-digit] inflation that we saw in the late 1970s and early 1980s. Right now, the money supply is very, very large, and that’s what the Federal Reserve has accomplished up to this point – increase the money supply and keep interest rates low so that people can pay off their debts.”

Droster said the Fed is “absolutely not concerned about inflation,” but is 100% focused on growing the economy and employment. “Until you have wage inflation, meaning more people with jobs and more people getting raises, you are not really going to have inflation,” she said. 

Brinkman said the Fed worries more about wage inflation than any other kind, and Madison might experience it sooner than most because unemployment has been coming down. “If employers are going to hire somebody, they are going to have to pay a higher wage than they did two years ago, so from that perspective there is going to be more inflation,” he said. 

Marilyn Holt-Smith, CEO and senior portfolio manager for Holt-Smith Advisors, noted that as the economy improves, inflation could go from 2% to 3%, but at the same time, bonds only are yielding 1% to 2%. “That’s disconcerting because savers and investors are settling for a lower real rate of return to stimulate the economy,” she said. “The Fed isn’t stimulating for free. There is a cost to it.”

Marker 2: Low Road Rates

Since Bernanke has pledged to keep interest rates at historic lows for the foreseeable future, investors should not expect interest rates to rise. Raising interest rates is the one tool the Fed has to fight off high inflation, but that tool likely will be kept in the box. 

When the economy gains traction, the Fed ideally would gradually raise interest rates over an extended period of time. According to Stephens, if inflation spikes and the velocity of money picked up “really, really fast,” that would prompt the Fed to raise interest raises high and fast. “You could potentially have a situation like you had in the late 1970s and early 1980s, where [then Fed Chairman] Paul Volker had to come in and raise rates so high,” he explained. “If you are forced into a situation where you have to raise rates really high, really fast, that can be a shock to the system. That’s what everyone is worried about.”

Marker 3: Bull Market Exit

Amid the uncertainty, one thing is certain – the long bull market in bonds is finally history. “We’ve seen declining interest rates since the early 1980s,” Holt-Smith said. “Ten-year Treasury bonds peaked at just over 15% in 1981, and that has pushed up total returns on bonds since. That has pretty much come to an end.”

Holt-Smith noted that interest rates should remain low, but people have to rely on that return on the fixed-income portion of their portfolio, and it’s not going to be more than 1% or 2%. “People with balanced portfolios have got to get used to lower returns,” she advised.


Marker 4: Valuation Underpass

If we can avoid the fiscal cliff, there is room for stocks to grow. In contrast to the tech bubble that burst in 2000, today’s stocks are undervalued. “In the late 1990s, people were paying much too much for what they were buying, relative to other things they could buy like commodities, bonds, or relative to what stocks usually are traded at historically,” Stephens explained. “Right now, they are fairly valued, maybe a little bit on the cheap side, so we don’t have the valuation risk that we had 10 years ago. We are left with just the earnings risk.”

Stocks might be undervalued for a while. “Stocks were cheap two or three years ago, and now we are hitting some three-year market-topping activities,” Brinkman said. “Pushing through that ceiling is going to happen, but it’s going to be a slow push. There will be a lot of testing of those tops, if you will.”

Marker 5: Destination: Diversity 

Given all the moving parts that start with the fiscal cliff, Holt-Smith said having a diversified portfolio will be important regardless of which political party is in charge. “Markets are going to remain volatile, so maintaining a diversified portfolio with stocks, bonds, and real estate is the best insurance against that,” she said. Beyond those pillars, Holt-Smith suggested that investors have some gold and some international exposure.

In addition, watch for moves toward self-sufficiency in energy, which “can present some interesting investment opportunities,” Holt-Smith advised. “The more the U.S. is self-sufficient in energy, the more it helps our economy.”

In the technology sector, Holt-Smith noted that personal computers are considered old hat, but investors still are seeing reasonable growth in smart phones, particularly outside the U.S. Companies that benefit from “the cloud” look good, but social media is still a crapshoot as it’s difficult for those businesses to generate profits.

Meanwhile, housing fundamentals are picking up, and energy is a space to watch, “so investors might want to have some portfolio exposure there,” Holt-Smith advised. 

Marker 6: Global GPS

The European economy and debt situation are still huge concerns, and with some disappointing third-quarter earnings reports, “our international businesses are saying it’s not getting any better in Europe,” Holt-Smith said. 

“They need to move forward on coming together on their fiscal entity,” she added. “So many nations have to act as one.”

China, which is under new leadership, will introduce a new five-year plan to make sure its economy grows, but not as fast as it has in the past. China also needs to consider banking reforms, spur innovation, and reform state-run monopolies because of recent scandals. 

“They have too much power focused in a few corporations running everything,” she said. “China’s economy might be near a low growth point [about 7% annually], but it’s still the second largest economy in the world, so your portfolio probably should have some exposure there anyway.” 

Sign up for the free IB Update – your weekly resource for local business news, analysis, voices, and the names you need to know. Click hereIf you are not already a subscriber to In Business magazine, be sure to sign up for our monthly print edition here.