As the “fiscal cliff” quickly becomes a fading memory, investors are now focusing their attention on the economy and corporate fundamentals. And what they have seen so far in 2013 they seem to like.
A January rally has taken the two blue chip barometers — the Dow Jones industrial average and the S&P 500 stock index — to the highest levels since December 2007, adding on to solid gains during 2012, a year where investors were challenged to stay the course.
“Politics dominated the year and the equity markets, even as a stalemate regarding budget talks and the looming fiscal cliff continued through the December 31 market close,” said Bob Doll, chief equity strategist at Nuveen Equity Management. “Thanks in part to solid earnings and strong cash flow yields, U.S. stocks closed the year with solid gains in total returns.”
The major indexes all posted double digit gains last year with the Dow industrials up 10.2 percent, the S&P 500 adding 16.0 percent, and the NASDAQ composite index rising 17.5 percent.
Perhaps what has been so impressive about the markets has been how far and how fast they have recovered from recessionary lows.
On March 9, 2009, the S&P 500 closed at 676. At the end of 2012 it was at 1,402, more than doubling in less than four years. The Dow industrials climbed from 6,547 on the same date to close out 2012 at 13,104, almost an exact double.
Yet, many investors are still haunted by the depths of the recessionary stock market correction and have missed most of the rebound. A survey by T. Rowe Price finds 37 percent of investors say they are now avoiding investments in stocks because of current economic or market conditions.
“The lack of faith in equities, even among long-term investors, is troubling. Historically, stocks have provided more long-term growth opportunities than bonds, short-term investments, and other vehicles that are generally considered to be more conservative,” said Stuart Ritter with T. Rowe Price.
“Investors aged 50 and under typically have enough time to overcome market setbacks and can decrease their exposure to stocks as they get closer to retirement.”
Some market observers tend to believe the easy money in stocks has been made over the past three years and stock selection will become more critical this year.
“The natural impulse when faced with economic and market uncertainty is to get defensive, which, admittedly, we have done over the last few years,” said Kelley Wright, managing editor of Investment Quality Trends, an investment newsletter based in Carlsbad.
“Our thought going forward, however, is to look to the more cyclical areas of the market for both growth of capital and income. To that end we are focusing more on the materials, industrials and energy,” Wright said.
One of the investment trends that flourished in 2012 and is likely to continue this year is the long-term benefit of companies paying substantial and appreciating dividends to shareholders. Nearly 45 percent of listed companies paid a dividend in 2012 and the average yield on these stocks is 2.80 percent.
“Investors are seeking income and companies are increasing their aggregate payout. However, while companies are paying out record dividends, these amounts are still significantly below historical payout rates,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indicies. “It’s not a matter of companies being cheap. It’s a matter of them being nervous about the economy and their resources, similar to most of us.”
Silverblatt points out the payout rate — the portion of earnings distributed as dividends — remain near the low of 36 percent. Payouts historically have averaged 52 percent, meaning there is plenty of room for companies to comfortably increase their distributions to shareholders.
Perhaps one of the most watched activities of 2013 will be when and if investors start moving money away from low-yielding bonds and bond mutual funds in favor of stocks. The renewed confidence of investors, plus the avoidance of the “fiscal cliff,” could encourage the change.
“The bond market remains highly linked to the economy, and is very concerned about how our leaders in Washington implement austerity, which has hindered growth in other countries. At the same time, an acceleration of growth could weaken the outlook for bonds,” said Christine Thompson, chief investment officer for bonds at Fidelity Investments.
Investing is always about balancing risk. After years of slow economic growth there is evidence the recovery — aided by a lively housing market — could finally move into a long period of expansion. But, as always, investors will keep a cautious eye on the nation’s Capitol as leaders address the debt ceiling and other issues.