The question going forward is whether or not investors can rely on valuation expansion to sustain market returns, or if earnings per share (EPS) growth can reaccelerate.
-Manning & Napier
The U.S. stock market has been relatively placid despite fears of the country going off the “fiscal cliff” at the end of 2012. In fact, even before the rumors of a compromise on the extension of the Bush era tax cuts, the S&P 500 Index was down only -1.3% from Election Day (November 6) through December 28. While the last minute deal on taxes was welcomed by the market (and most taxpayers), the reality is that politicians have only pushed off several difficult decisions for a few months. Rather than trying to forecast the outcomes of these political issues, we believe that the best way to succeed as investors in 2013 is to be prepared for whatever might come our way. Our market return expectations for the calendar year are relatively modest, but flare ups in market volatility may provide attractive opportunities for investors who are prepared to act in the face of fear and uncertainty.
Base Case for 2013: Most Signs Point to Modest Returns
Our market expectations are informed by a variety of indicators which seek to gauge the degree to which the business cycle, valuations and sentiment are likely to impact returns over the intermediate-term. Manning & Napier’s publication, View from the Top Down, features the Economic Clock and the Quantitative Indicator Report which are two such tools developed to help us to monitor these factors. Generally speaking, market return expectations are greatest (and the risk of a sustained loss is lowest) when valuations are low, sentiment is pessimistic and the economy is very weak. Conversely, market returns expectations are lowest (and the risk of a sustained loss is highest) when valuations are high, sentiment is bullish and the economy is very strong. Charts 1, 2 and 3 show the current aggregate economic, valuation and sentiment readings. We are in somewhat of an indicator no-man’s land today, with few extremes arguing for either robust gains or sustained losses.