In Money magazine’s Make More in 2013 you’ll learn how the economy will change in the year ahead, why, as a prospective home seller or buyer, you need to stop sitting on your hands, and how you can start exploring job opportunities again. This installment: Learn how to get more investment income at a time of super-low rates.
Given all the disconcerting headlines you’ve read about the economy this year, “it feels like the markets should be down 10%,” says David Hallman, chairman of the investment committee at United Capital Financial Advisers. Yet through the end of October, U.S. stocks were up around 14%, while a broad index of international shares was also up by double digits.
Chalk some of that up to the power of central banks, which have been driving investors into risky assets like stocks by keeping interest rates low.
The Fed promises to continue to keep a lid on rates throughout the year — and beyond. And 2013 should be filled with yet more economic uncertainties. But don’t bank on a repeat of such astounding gains.
Why not? Wall Street is becoming increasingly worried about slowing revenue growth among S&P 500 companies. Without a strong jump in demand, stocks will be hard-pressed to produce another year of better-than-average returns.
The news isn’t all bad, though. Even after this year’s rally, equities aren’t overly expensive based on traditional price/earnings ratios. S&P Capital IQ projects a 6% price gain for U.S. stocks over the next 12 months. Tack on dividends and you’re looking at total returns in the vicinity of 8%.
That’s more than double what you should expect from a core portfolio of high-quality bonds, market strategists say. In this low-rate environment, in fact, high-quality bonds are unlikely to return much more than their coupon. (The Barclays U.S. Aggregate Bond index currently yields a paltry 2.5%.)
Nevertheless, by seeking out undervalued parts of the market — such as nontraditional sources of dividend income and noncore bonds — you can still make decent money in 2013. Here’s how:
THE ACTION PLAN
For growth, go big: While S&P 500 profits have nearly doubled since the financial crisis, sales have grown by just single digits, notes George Fraise, portfolio manager at Sustainable Growth Advisers. You want companies thriving by expanding revenue, not just cutting costs. That means global firms that can go wherever growth is.
MONEY 70 funds Jensen Quality Growth and T. Rowe Price Blue Chip Growth focus on multinationals such asColgate-Palmolive and Google .
Also, “there are great companies based in Europe that in fact do a lot of business outside Europe,” says Fort Pitt Capital analyst Denny Baish. Tweedy Browne Global Value homes in on such firms, like Swiss-based Nestlé, which gets nearly a quarter of its sales from Asia Pacific and Africa.
For income, think outside usual boxes: With a majority of stocks in the S&P 500 sporting yields higher than that of 10-year Treasuries, it’s no surprise investors are turning to equities for income.
Yet many traditional dividend sources — like utility and telecommunications shares — have been bid up so much in recent years they’re trading at premiums to the market when historically they’ve been at discounts.
Mark Freeman, manager of Westwood Income Opportunity, suggests looking elsewhere next year.
The best values, he says, are in the health care, technology, and energy sectors. WisdomTree Large Cap Dividend (2.8% yield) has one-third of its assets in those areas and less than 6% in utilities. Among the top 10 holdings of Vanguard High Dividend Yield ETF (3.0%) are ExxonMobil , Microsoft , and Johnson & Johnson .
Don’t shortchange yourself: Uncertainty usually pushes investors into the relative safety of short-term bonds. But since the Fed will keep short-term rates near zero through at least mid-2015, next year is not a time to bet big on cash or short-term debt, says James Kochan, fixed-income strategist at Wells Fargo Advantage Funds.
His recommendation: Intermediate-term issues with maturities in the five-to-10-year range. While short-term bond funds are yielding just 2% — the same as inflation — intermediates are paying 3.2%. MONEY 70 member Dodge & Cox Income yields much more: 3.7%.
Wean yourself from Uncle Sam: More than 70% of the Barclays U.S. Aggregate Bond index is tied to U.S. government and agency bonds, where yields are at historic lows.
“Outside of a crisis, government debt is a horrible investment,” says Jeff Layman, chief investment officer at BKD Wealth Advisors. New money should go to better values, Kochan argues.
Loomis Sayles Bond currently keeps more than 40% of assets in corporate debt rated at the low end of the high-quality universe or at the high end of junk. Harbor Bond — led by Pimco’s Bill Gross — dabbles in foreign and high-yield bonds.
The Money tracker: What can upset the forecast in the year ahead…
China re-accelerates. Should the slowdown in the world’s second-biggest economy reverse, it would lift foreign stocks in general and emerging-markets equities.
The return of inflation. Central banks can goose the economy because inflation is tame. But even Uncle Sam thinks food costs could jump, which would tie policymakers’ hands.
Share buybacks surge. If cash-rich companies such as IBM continue to purchase their own stock, corporate earnings — on a per-share basis — will see an automatic boost. That would be a potential tail wind for equities.
Taxes on dividends go up. A rise in the tax on qualified dividends could dampen the market’s love affair with income-paying stocks. However, if Congress offers another “tax holiday” for companies to repatriate overseas profits, that could increase dividend payouts.
The running of the bears. The fact that pessimism is on the rise — 45% of individual investors consider themselves bearish, up from just 20% earlier this year — may be a counterintuitive sign of stronger-than-expected stock returns in 2013.