volume 84 2013 - td ameritrade...this recommendation takes into account both fast changing market...

Economic Outlook Asset Allocation

Market Forecast International Outlook

2013 Predictions Mutual Funds

ETF Strategies Well-Balanced Portfolio

Standard & Poor’s 500 Composite1941–1943 = 10

(Logarithmic Scale)(Gray areas represent declines of 10% or more)

Annualized Total Return from 12/31/69 through 11/30/12 was 9.89% with dividends reinvested quarterly.

THE OUTLOOKINTELLIGENCE FOR THE INDIVIDUAL INVESTOR

FFORECASTANNUAL

FORECASTANNUAL20132013December 17, 2012

Volume 84Number 46

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2 S&P CAPITAL IQ THE OUTLOOK DECEMBER 17, 2012 www.spoutlook.com

A Half-Hearted RecoveryThe U.S. is expanding more rapidly, but the pace is still lackluster.

It may not really feel that way, but looking at the numbers, a sustained and strengthen-ing economic recovery awaits the U.S. in the year ahead. It just won’t be that exciting.

The job market is improving, if slowly. The housing market has apparentlyreached bottom and is now starting to revive as well. Consumer confidence is fair-ly strong, keeping auto sales buoyant. Interest rates are low, and the FederalReserve has promised to keep them low — provided inflation stays tame — “atleast” until unemployment drops below 6.5%. That might take a while.

“We have some solid reasons to feel optimistic,” says Beth Ann Bovino, Standard &Poor’s Economics deputy chief economist. “It looks like the economy could finally bein a self-sustaining recovery, and even Hurricane Sandy is unlikely to stop this trend.”

Don’t get too excited, though: the U.S. economy won’t heat up much in 2013.Bovino forecasts gross domestic product growth of 2.3% next year, compared with2.1% for 2012, but that should accelerate again to 2.7% in 2014 and 3.1% in2015, led in large part by a rebound in housing.

Of course, the major threats to the domestic and global economy are still far fromresolution. In the U.S. a January 1 deadline hangs over income tax rates and auto-matic federal spending cuts, and further acrimony lies ahead as the government isset to reach its legal borrowing limit sometime in the first three months of the year.In Europe, bond yields have receded from their 6% “Red Alert” levels, but Spain hasnot yet requested the bailout it is widely believed to need and brinksmanship overfunds needed by Greece to avoid default has almost become a spectator sport.China’s economy appears to be reversing a worrisome slowdown earlier in the year,though a return to the days of better than 10% annual growth seems unlikely any-time soon.

How these threats impact global equity markets in 2013 is anyone’s guess.While the potential is there for any of them to widen and put a damper on therecovery, so too is there the chance for a positive resolution that would clear theway for a significant rally.

For now, markets will draw strength from the “proactive” attitude of the FederalReserve, says Sam Stovall, S&P Capital IQ chief equity strategist, especially itsdecision to directly link interest rate policy with employment rates. “By indicatingthat they will maintain this asset-purchase program until unemployment andinflation thresholds have been met, rather than focusing on a fixed-date target,we believe the Fed is signaling that they aim to stimulate inflation-controlled eco-nomic growth,” he says. ■

—Vaughan ScullyS&P Capital IQ Editorial

S&P CAPITAL IQ EVALUATION SYMBOLSSTARS RankingsOur evaluation of the 12-month potential of stocks is indicatedby STARS:

Strong Buy—Total return is expected to outperformthe total return of a relevant benchmark by a widemargin over the coming 12 months, with shares rising in price on an absolute basis.Buy—Total return is expected to outperform thetotal return of a relevant benchmark over the coming 12 months, with shares rising in price on anabsolute basis.Hold—Total return is expected to closely approxi-mate the total return of a relevant benchmark overthe coming 12 months, with shares generally rising inprice on an absolute basis.Sell—Total return is expected to underperform thetotal return of a relevant benchmark over the com-ing 12 months, and the share price is not anticipatedto show a gain.Strong Sell—Total return is expected to underper-form the total return of a relevant benchmark by awide margin over the coming 12 months, with sharesfalling in price on an absolute basis.

NR Not ranked.

Quality Rankings (QR)Our appraisals of the growth and stability of earnings and divi-dends over the past 10 years for STARS and other companies areindicated by Quality Rankings: A+ Highest B+ Average C LowestA High B Below Avg. D In reorganizationA- Above Avg. B- Lower NR Not RankedQuality Rankings are not intended to predict stock price movements.

MARKET MEASURES

Data through 12/14/12. E-Estimated. †Based on estimated 2012 earnings. ‡Before special factors. ◊Actual changein yield (not percentage change). Sources: S&P Capital IQ and Thomson ONE.

E D I T O R I A LSenior Editorial Manager Vaughan Scully

Contributing Editors Brian J. Egli, Art Epstein,Isabelle Sender

R E S E A R C H & A N A LY T I C SManaging Director, Global Equity Research

Stephen Biggar

Editorial Director Beth Piskora

S&P Capital IQ’s The Outlook

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The Outlook is a publication of Standard & Poor’s InvestmentServices. This department operates independently of, andhas no access to, non-public information obtained byStandard & Poor’s Ratings Services, which may in its regu-lar operations obtain information of a confidential nature.Information included in The Outlook may at times be incon-sistent with information available in S&P Capital IQ’sMarketScope, an electronically delivered online service.Permission to reprint or distribute any content from thisnewsletter requires the written approval of S&P Capital IQ.

CLOSE % CHG. % CHG. ‡OPERATING †P/E RATIO INDICATEDFRI. YEAR TO PAST —EARNINGS— FRI. ANNUAL %

INDEX 12/14/12 DATE 52 WKS. 2011 E2012 12/14/12 DIVIDEND YIELD

S&P 500 Composite 1413.58 12.4 15.9 96.44 $99.46 14.21 32.40 2.29 S&P MidCap 400 1001.53 13.9 17.0 50.31 $55.51 18.04 15.42 1.54 S&P SmallCap 600 461.39 11.2 14.3 20.59 $22.57 20.44 8.24 1.79 S&P SuperComposite 1500 326.33 12.5 15.9 21.50 $22.32 14.62 7.22 2.21

Dow Jones Industrials 13135.01 7.5 10.7 … … … … …Nasdaq Composite 2971.33 14.1 16.3 ... ... ... … ...BBB Indus. Bond Yield (10-yr.) 3.80 -0.69 ◊ -0.69 ◊ ... ... ...

Going back to 2011, theS&P Capital IQInvestment PolicyCommittee has advisedholding a neutral assetallocation: the recom-mendation is presently45% domestic equity,15% foreign equity(10% developed and 5%emerging market),along with 25% fixedincome and 15% cash.This recommendationtakes into account bothfast changing marketconditions and the deli-cate balance betweenequity valuations andexpected earnings growth on onehand, and political risks among othersto the global economy on the other.

The last time the recommendationwas changed was in March, 2011,when the committee voted to reduceits 20% foreign equity allocation to15%, and raise its fixed income alloca-tion from 20%.

The 45/15 split between domestic andinternational equities is in line with thecommittee’s custom benchmark, saysAlec Young, S&P Capital IQ global equitystrategist, but allocating 5% within theinternational allocation to emergingmarkets is something of a departure,and represents the committee’s bullishview on emerging market equities rela-tive to developed international.

“The reasons for our ‘overweight’stance include our view that emergingmarkets will outperform developed

international equities in 2013,” Youngsays, based in part on the discountvaluation emerging markets trade atcompared with both their long-termaverage and current valuations fordeveloped nations such as Canada,Australia, Europe, and Japan. He seesan improvement in emerging marketeconomic growth, including a reboundin China’s growth in late 2013, as wellas a stabilization of the European sov-ereign debt crisis helping emergingmarket equities rally in the year ahead.

Young recommends investors gainemerging market exposure via broadlydiversified funds than trying to singleout a single country or region for out-performance. “Country calls matterless when broad index performanceramps up as you’re maintaining solidreturns despite having less risk,” hesays. “We’d rather play this via thebroad index given our bullish outlook.”

On a sector basis, the committeerecently upgraded its recommenda-tion for industrials to “overweight”from “marketweight.”

“We believe this sector is positionedto outperform the broader market asinvestors discount further Fed policyaccommodation, an expected gradualimprovement in global GDP in 2013and economic stabilization in China onthe heels of the recent improvementin Chinese economic data,” Stovallsays, “despite the sector’s slight valu-ation premium on 2013 EPS estimatesof 12.8, versus the broader market’s12.6 multiple.”

In addition to its industrials rec-ommendation, the committee has“overweight” recommendations onthe consumer discretionary andhealth care sectors, and “under-weight” recommendations on materials and utilities. ■

MODERATE PORTFOLIO

www.spoutlook.com S&P CAPITAL IQ THE OUTLOOK DECEMBER 17, 2012 3

Global Asset Allocation UpdateThe allocation model is unchanged.

Vaughan ScullyS&P Capital IQ

Editorial

YTDANNUALIZED

ASSET CLASS/ S&P TOTAL CURRENTALLOCATION INVESTMENT STYLE ETF/TICKER RANKING RETURN (%) PRICE

45% U.S. STOCKS37 Large-Cap Blend SPDR S&P 500 / SPY OW 15.35 $142.63

5 Mid-Cap Blend S&P MidCap 400 SPDR / MDY OW 15.58 $183.373 Small-Cap Blend iShares S&P SmallCap 600 / IJR OW 16.76 $76.44

15% FOREIGN STOCKS10 International iShares MSCI EAFE / EFA OW 15.48 $55.88

5 Emerging Markets iShares MSCI Emerging Markets / EEM MW 15.23 $43.1925% BONDS20 U.S. Debt iShares Barclays U.S. Aggregate / AGG NR 3.61 $111.15

5 U.S. Short-Term Debt iShares Barclays 1-3 Year Treasury / SHY NR 0.29 $84.4415% CASH U.S. 6-Month Treasury Bills

Total = 100%*Data as of 12/13/12. The Outlook’s Moderate ETF Portfolio was up 9.3% year to date through November 30 vs. a gain of 10.0% for its custom benchmark.

Portfolio Changes:

BB&T (BBT 28.58 ★★★★★) and Trinity Industries (TRN 34.17 ★★★★★) were added to, while Express Scripts (ESRX 54.12

★★★★) and Travelers (TRV 73.23 ★★★) were deleted from, the Platinum Portfolio effective Tuesday, December 11.

The election is over, the status quohas been re-elected, and the globalheadwinds remain unchanged. Wheredo we go from here?

S&P Capital IQ’s Investment PolicyCommittee has a 12-month forwardtarget on the S&P 500 of 1550, implyingan 8.5% advance from the December 12close. Our base case scenario calls forgradually accelerating growth in the U.S.and global economy, a sequential quar-terly recovery in S&P 500 earnings-per-share (EPS) growth rates, and shareprices that are supported by modestvaluations, low rates, and bearish senti-ment. Despite the potential for highertax rates on dividends, we still recom-mend high-yielding equities, providedthey carry above-average S&P Capital IQQuality Ranks and STARS.

If This Were a Normal First YearIf this were a “normal” first year of a

president’s term in office, we would notexpect too much out of the U.S. equitymarket. Since 1900, the S&P 500 hasposted its weakest performance in thefirst year of the four-year presidentialcycle, rising an average 4.3% andrecording a positive performance 57% ofthe time. Following the re-election of thePresident or his party, the “500” did alittle better, however, gaining 4.7% andrising in price 65% of the time. Bothreturns are higher than what historysays, but doesn’t guarantee, could havebeen expected had the Republicansregained control of the presidency, asthe S&P 500 rose only 3.7% on average,and increased in price only 45% of thetime, when the incumbent was replaced.

Yet first-year stock market resultshave traditionally been weak, as theparty in power seeks to address nation-al ills early on, so they may be resolved(or forgotten) by re-election time. Thistypical lack of stimulus — and at timesoutright recession — weighs heavily on

investor confidence. This time around,we have an additional worry: the grid-lock that has historically come from adivided Congress, which will likely havequite a dampening effect on the stockmarket’s performance.

The S&P 500 has risen by an aver-age 6.7% during all calendar yearssince 1901. During years when theexecutive and legislative branches ofgovernment were controlled by thesame party (which happened 66 yearsout of 112), the S&P 500 advanced anaverage 7.6%. Whenever the Presidentwas from one party but both houses ofCongress were from another party,which occurred 34 times, the marketgained an average 6.2%. Yet whenCongress was split, which happenedonly 12 times, the market’s averageannual advance dropped to 3.7%, orless than half of the average perform-ance under a totally unified govern-ment. (An interesting factoid is thatthe S&P 500 performed best underDemocratic presidents, regardless ofCongressional makeup.) This year,pressure will fall upon a split Congressto prove that they can lead rather thanimpede.

Factors in Our FavorDespite the plethora of obstacles

facing investors today, we are cau-tiously bullish on the coming year for avariety of reasons:

¬ A U.S. economy that is likely to gain,rather than lose, altitude.

¬ The projected trough in global grossdomestic product (GDP) growth.

¬ A modest “v”-shaped trajectory inEPS expectations.

¬ Attractive trailing and projected val-uations.

¬ Improving international equityexpectations.

¬ Excessive bearish sentiment.

EPS Deceleration Reversal?The deceleration in quarterly year-

over-year growth for S&P 500 operat-ing earnings per share has been ofconcern for many investors over muchof the past year, but the summerslump is expected to be the low pointfor this earnings cycle. Wall Streetestimates call for sequentially highergrowth between the fourth quarter of2012 and the fourth quarter of 2013.

Granted, these estimates could bevulnerable to further downward revi-sions, encouraged by still-weak revenuegrowth, but not likely in isolation.Revisions to the expected quarterlytrough in global GDP growth, indeed thegeneral outlook for most growth driversin the coming year, would be required inorder to justify a dramatic reversal inEPS growth projections, in our opinion.

Attractive Valuations (if You Believethe Estimates)

As of November 23, the S&P 500 traded at 13.9-times trailing 12-monthoperating EPS, representing a 22% discount to the median multiple of 17.9since 1988. The market is currently trad-ing at only 12.4-times projected 2013results, a 31% discount to the median.Since some call operating results “earn-ings before bad stuff,” we note that theS&P 500 is trading at 16.1-times GAAPearnings per share, which is a 21% dis-count to its median since 1988. What’smore, if you are like the author JamesMichener and prefer to go back to thebeginning of time, you will see that theS&P 500 is trading near its median mul-tiple since 1936, and at an 11.5% dis-count on 2013 estimates.

The gap between bottom-up EPS esti-mates for the S&P 500 (based on indi-vidual company forecasts brought up tothe S&P 500 level) and top-down (basedon global GDP growth estimates whittleddown to the S&P 500 level) is again


2013 U.S. Equity OutlookModest appreciation expected, with upside surprise potential.

Sam StovallS&P Capital IQ

Chief Equity Strategist


relatively wide. The 2013 bottom-upestimate, according to Capital IQ consensus estimates, is $113.19/share,versus our top-down estimate of$107.73/share. Based on the currentmultiple of 13.9, these two numberspoint to very different possible year-end2013 valuations of 1573 and 1497,respectively. Also, this target band couldwiden further should investors expand orcontract the multiple due to changingassumptions: A multiple of 15 on$113.19 supports a target of 1698, while12.5 on $107.73 justifies an S&P 500target of 1347.

Equities: Focus on QualityThere have been a variety of recom-

mendations by strategists on which

sectors and stocks are likely to be beneficiaries of a President Obama re-election. Yet many of these groupsand issues have already been bid up, inour opinion, and are now less attractive.One approach that we believe will nevergo out of style — regardless of party inpower or tax policy embraced — is thefocus on reasonably priced quality.Whatever the conclusion of the currentfiscal cliff standoff, higher taxes on div-idends will likely be included, in ouropinion. Yet, that doesn’t mean thatinvestors should avoid dividend-payingstocks. First, it is becoming increasingdifficult to find stocks without a yield,as 80% of S&P 500 companies now paya dividend. Second, the tax on dividends, at worst, will be equal to that

on bonds, in our opinion. And with theyield on bonds near historical lows, andthe economy likely to pick up the pacerather than slip back into recession, webelieve there is greater risk to owningbonds than dividend-paying stocks.

So there you have it. S&P CapitalIQ’s Investment Policy Committee seesthe S&P 500 posting a modestadvance in price to 1550 in the com-ing 12 months on a gradual increasein global economic growth rates,sequential improvement in quarterlyearnings, attractive trailing and pro-jected valuations, and still-bearishinvestor sentiment. Granted, the casefor another recession and bear marketmay sometimes sound convincing, yetthis negative scenario has been inplace for months and the S&P 500 hasadvanced more than 10% from itsearly-June low. We believe the marketis looking beyond the troughs in GDPand EPS growth. And while debt dis-cussions from Europe and the com-bative rhetoric from Washington willlikely keep investors’ nerves on edge,we believe equities offer a moreattractive investment opportunity thanbonds. We recommend screening forhigh-quality issues with favorable relative valuations that offer above-market dividend yields. ■

2013 U.S. Equity Outlook (Continued)

S&P 500 OPERATING EPS Y/Y % GROWTH PROJECTIONSY/Y EPS % CHANGES P/E RATIOS S&P DIVIDEND

S&P SECTORS 2012E 2013E 2012E 2013E STARS YIELD

Cons. Discretionary 6.7 15.0 17.2 14.9 3.6 1.7%Consumer Staples 4.2 9.0 16.8 15.4 3.9 2.9%Energy (6.1) 6.0 11.7 11.0 4.3 2.3%Financials 12.0 9.8 12.1 11.0 3.5 1.9%Health Care 1.4 6.4 13.5 12.7 3.9 2.2%Industrials 10.0 7.4 13.7 12.8 3.5 2.4%Information Technology 5.0 12.4 12.9 11.5 3.7 1.8%Materials (12.5) 22.3 15.3 12.5 2.9 2.6%Telecom. Services 2.1 21.3 20.4 16.8 3.2 4.8%Utilities (5.3) 2.7 14.7 14.3 3.2 4.4%S&P 500 3.7 10.0 13.8 12.6 3.7 2.3%Source: S&P Capital IQ.

YEAR-OVER-YEAR % CHANGES IN CAPITAL IQ S&P 500 CONSENSUS OPERATING EPS ESTIMATES

19.7% 19.2%17.6%

8.4%7.5%

0.9%2.5%

4.3% 4.0%

9.2%10.3%

16.9%

0.0%

5.0%

10.0%

15.0%

20.0%

2011 Q1A

2011 Q2A

2011 Q3A

2012 Q4A

2012 Q1A

2012 Q2A

2012 Q3E

2012 Q4E

2013 Q1E

2013 Q2E

2013 Q3E

2013 Q4E

Source: S&P Capital IQ.

Consensus economic projectionsreveal only cautious optimism forglobal growth in 2013. The U.S., U.K.,eurozone, Japan, and Canada —which combined represent 60% ofglobal gross domestic product (GDP)— are all seen growing by 2% or less.Growth is forecast to reach an annualrate of 3% by the fourth quarter from2.2% in the first quarter. Overall,global real GDP growth is estimatedat 2.6% in 2013, up slightly from the2.2% seen for 2012, according to aBloomberg consensus estimate. Webelieve this cautious outlook reflectsthree significant macroeconomicrisks to the health of the global econ-omy: the resolution to the U.S. “fiscalcliff,” Europe’s recession and debtcrisis, as well as the still unknowntrajectory of China’s growth. All threewill go a long way to shape corporate

profitability, and hence our analysisof the 2013 overseas equity outlookbegins there.

The U.S. Fiscal CliffConsensus expectations for 2% U.S.

GDP growth in 2013 clearly imply mar-kets expect a solution that would miti-gate the effect of the $668 billion inspending cuts and tax increases set totake hold on January 1, 2013. Webelieve the mere possibility of such anunprecedented macro headwind hasserved to dampen both U.S. and inter-national growth expectations and withit, equity performance. An extension ofcurrent U.S. tax rates for at least sixmonths coupled with a bipartisanagreement to tackle comprehensivetax and entitlement reform in 2013 isneeded to diffuse investor concernover this issue, in our view.

The European Sovereign Debt CrisisStill ailing from its three-year-old

sovereign debt crisis, Europe dippedback into recession in the third quarterof 2012 as austerity-induced spendingcuts and tax increases stoked risingunemployment, especially in southernEuropean countries like Spain, Italy,and Greece. However, in part due to aproactive monetary policy from theEuropean Central Bank, the consensussees the eurozone recession ending bythe third quarter of 2013. WithEurope’s economy recording little or nogrowth for several years now, marketshave largely discounted the region’sweakness, in our view.

While the pace of any 2013 recov-ery will have some bearing on earn-ings-per-share (EPS) growth andequity performance, we see equitiestrading more in correlation with sov-ereign stress indicators in Europeanbond markets. Over the past fewyears, international stocks havemoved in virtual lockstep withperipheral-nation sovereign bondyields. After a brutal spring swoon,equity performance has improvedsince July when European CentralBank President Mario Draghi vowedto defend the euro at all costs andintroduced a bailout plan that drovedown borrowing costs for heavilyindebted nations. Overall, we thinkthe worst of the European sovereigndebt crisis is behind us.

Chinese GrowthAs the world’s fastest-growing

major economy, we think China’s abili-ty to maintain strong growth is key tothe global outlook, especially givenEurope’s recession, anemic growth inJapan, and the risk of fiscal drag inthe U.S. Recent news has beenencouraging, with industrial produc-tion, retail sales, and exports all


2013 International Equity Outlook Modest prospects for 2013 make dividend yield a key.

Alec YoungS&P Capital IQ

Global Equity Strategist

CONSENSUS SEES MODEST, UPTICK IN GLOBAL GROWTH IN 2013Q3 ‘12E Q4 ‘12E CY 2012 Q1 ‘13E Q2 ‘13E Q3 ‘13E Q4 ‘13E CY 2013

World 1.5% 2.0% 2.2% 2.2% 2.5% 2.8% 3.0% 2.6%Advanced Econ. 0.9% 0.9% 1.2% 0.7% 1.0% 1.1% 1.4% 1.1%U.S. 2.0% 1.9% 2.1% 1.8% 2.1% 2.1% 2.1% 2.0%Eurozone -0.8% -0.5% -0.5% -0.4% -0.1% 0.6% 1.0% 0.3%Germany 0.6% 0.8% 0.9% 0.6% 0.7% 1.1% 1.5% 1.0%France -0.2% -0.2% 0.1% -0.1% 0.2% 0.6% 1.0% 0.5%Italy -2.9% -2.4% -2.4% -1.6% -0.8% -0.2% 0.3% -0.6%Spain -1.9% -2.1% -1.5% -2.2% -1.9% -1.5% -0.4% -1.5%Switzerland 1.3% 1.2% 1.0% 1.0% 1.3% 1.9% 2.2% 1.0%U.K. 0.0% 0.1% -0.3% 0.6% 1.4% 1.1% 1.4% 1.1%Canada 1.8% 1.8% 2.1% 1.8% 1.9% 2.1% 2.2% 2.0%Australia 2.7% 2.8% 3.5% 1.9% 1.8% 2.1% 2.4% 3.0%Japan 1.6% 1.7% 2.1% 0.6% 0.9% 1.3% 1.7% 1.0%Emerging Mkts. 4.8% 4.9% 4.9% 5.0% 5.2% 5.2% 5.3% 5.2%China 7.4% 7.7% 7.7% 7.9% 8.0% 8.2% 8.0% 8.1%India 5.6% 5.5% 5.6% 5.8% 5.8% 6.0% 6.2% 6.0%South Korea 2.0% 2.2% 2.5% 2.0% 2.4% 3.5% 3.6% 3.1%Brazil 1.9% 2.7% 1.5% 3.7% 4.1% 3.9% 4.2% 4.0%Mexico 3.5% 3.5% 3.8% 3.2% 3.2% 3.5% 3.8% 3.6%Russia 2.9% 3.0% 3.7% 3.0% 3.4% 3.8% 3.8% 3.6%Turkey 2.5% 3.6% 3.0% 4.2% 4.0% 3.9% 4.0% 4.0%South Africa 2.6% 2.5% 2.5% 2.5% 2.6% 3.1% 3.4% 3.0%

Source: Bloomberg, IHS Global Insight (through 11/15).


rebounding from their summertroughs. In addition, Chinese manu-facturing moved back into expansion-ary territory in October led by arebound in new orders and production.With inflation tame at less than 2%,we see room for additional fiscal andmonetary policy easing in the secondquarter of 2013. The consensus seesChina’s 2013 growth in “soft landing”territory at 8.1%, according toBloomberg estimates.

India’s growth should reboundsomewhat to 6% next year from anestimated 5.6% this year, according toconsensus, although stubbornly highinflation of 7.9% is precluding moreaggressive central bank stimulus. Asfor Brazil, growth is expected torebound to 4% from 1.5% in 2012.Lastly, other major developingeconomies like Mexico, Russia, SouthAfrica, and Turkey are all seen postinghealthy 3% to 4% growth next year.Overall, IHS Global Insight, an inde-

pendent forecasting firm, sees emerg-ing economies posting collective GDPgrowth of 5.2% in 2013, up from anestimated 4.9% in 2012.

Since we don’t see 2013 as a ban-ner year for international stocks, werecommend a focus on equity incomeas a means of supplementing totalreturns. International equities gener-ally yield more than their U.S. coun-terparts, with developed Europeanmarkets leading the way. However,high yields don’t tell the whole story.Instead of reaching for yield, we sug-gest seeking out high levels of cur-rent income combined with dividendpayout ratios below 60%. On thatbasis, we see the emerging marketasset class offering attractive incomepotential, as its 3.1% yield is pairedwith only a 36% dividend payout ratio,well below the elevated 87% payoutratio of the MSCI EAFE Index of devel-oped overseas stocks. At the countrylevel, Brazil jumps out to us as

attractive, with a healthy yield of3.8% and a dividend payout ratio of49%. On the developed side, we seeSwitzerland and France as the bestoverall income plays since they offeryields of 3.8% and 4.4%, respectively,while maintaining what we considerto be reasonable dividend payoutratios of 59%, and 56%.

ConclusionWhile 2013 global macroeconomic

visibility is less than stellar, we seeboth developed foreign and emergingmarket stocks rising modestly nextyear, with dividend yields key to totalreturn. Given our view that the fullbrunt of the U.S. fiscal cliff will beavoided, China will maintain growth inthe 7.5%-8% range, and a Lehmanmoment will likely fail to transpire inEurope, we see mid-single digit EPSgrowth in 2013, and we believe currentvaluations leave room for modestequity price appreciation. ■

2013 International Equity Outlook (Continued)

LOWER DIVIDEND PAYOUT RATIOS ENABLE DIVIDEND GROWTH

0% 20% 40% 60% 80% 100% 120% 140% 160%

SpainU.K.

JapanAustralia

EAFEGermany

ItalySw itzerland

FranceS. Africa

IndonesiaBrazil

S&P 500Emerging Markets

RussiaIndia

MexicoChina

South KoreaTurkey

2012E Dividend Payout Ratio

Source: Bloomberg (through 11/16).


The imminent arrival of a new yearmarks as good occasion as any forupdating portfolios to reflect expectedmarket conditions in the year ahead.To help with that, equity analysts atS&P Capital IQ have compiled a list ofpredictions for 2013, organized bysector.

Consumer DiscretionaryWe expect companies in the con-

sumer discretionary sector to keep upa healthy pace of share buybacks in2013. Among retailers, we see moder-ating top-line growth for specialtyapparel retailers due to tougher com-parisons and increasing internationalcompetition. Strong demand for low-priced items will likely push dollarstores to expand their square footage.

We project e-commerce retail salesgrowth of approximately 15%, drivenby increased shopping on smart phonedevices. We think retail sales channelswill move towards convergence, withconsumers viewing online, mobile, andbrick-and-mortar offerings as oneintegrated channel.

We expect hotels to see improvedresults in 2013, helped by supplygrowth of less than 1% and a reboundin group travel. While Las Vegas andother regional markets should experi-ence uneven performance for casinosand gaming companies, Macau shouldbe relatively healthy.

Consumer StaplesWe see consumer staples compa-

nies increasing their use of theInternet for marketing, promotion,brand-building, and identification ofconsumer interests/trends.

There should be a further shifttoward what are perceived as healthierand environmentally friendly products.We think branded goods companies

will have limited ability (and interest)in raising prices due to a sluggish con-sumer environment and competitivefactors, including private label.

For tobacco, we expect pricing torise, albeit offset from time to time bypromotions, and the introduction ofnew products such as e-cigarettesand other smokeless nicotine prod-ucts. Spirits sales should be healthyon higher pricing and emerging mar-ket growth. We are cautious on beergiven what we see as increasing com-petition, particularly in the craft seg-ment, consumer preference movingaway from beer, and higher inputcosts. In non-alcoholic beverages, weexpect product news to be driven bynon-carbonated beverages, naturalsugar substitutes, and mid-caloriecarbonated beverages.

EnergyWith 2013 should come a slight

narrowing of the spread in pricebetween the international benchmarkgrade, Brent Blend, and the U.S.benchmark West Texas Intermediate.We expect the Brent-WTI differentialto vary from $15 per barrel to $18 perbarrel. Although our forecast is belowNovember’s $22.52 per barrel spread,it is still well above the $3 per barrelto $4 per barrel average from 2006 to2012. We expect infrastructure build-out from the trading hub at Cushing,Oklahoma to the Gulf Coast and fromthe Permian Basin to the Gulf Coastto help narrow the spread. We esti-mate new and expanded pipelinesfrom Cushing and the Permian Basinto the Gulf Coast will add more than1.3 million per day of capacity in2013.

U.S. land rig counts should declinein 2013. As of December 7, 2012, theU.S. lower 48 rig count stood at 1,800

rigs, down almost 10% from a yearearlier. We see a further reduction ofabout 5% in 2013, as customers useimproved drilling techniques and tech-nology to drill the same number ofwells with fewer rigs.

We see the U.S. Gulf of Mexico deep-water recovery extending in 2013. Thecount of active deepwater drillingunits in the U.S. Gulf stood at 33 at thetime of the April 2010 oil spill, and nowstands at 39 units. We think that byyear-end 2013, the active deepwaterrig count will number 45 or more, anuptick of more than 35% versus pre-spill levels.

FinancialsWe see investment banks and bro-

kerage firms are reducing risk levelsand capital to match lowered expecta-tions for sales and trading and invest-ment banking. We see retail realestate investment trusts benefittingfrom healthy demand for retail spaceand a lack of new supply.

While we see the three largest banks— JPMorgan Chase (JPM 42.78★★★★), Bank of America (BAC 10.54★★), and Citigroup (C 37.29 ★★★★)reporting little if any revenue growth in2013, that’s a significant improvementfrom a 5% decline seen in 2012 and a10% decline in 2011.

We see retail real estate investmenttrusts benefitting from healthydemand for retail space and a lack ofnew supply, with occupancy and rentalrates improving over the year.

We believe that life insurers will beadversely affected by low interestrates, but their diversified businessmodels should help offset that.Property-casualty insurance pricingwill firm, we believe, though there stillexists excess underwriting capacity inthe marketplace.

What to Look for in 2013Highlights of S&P Capital IQ equity analysts’ predictions. ANNUAL

FORECAST

2013

For custody banks, consumerfinance, and asset management com-panies, we see a slow and slightlyvolatile economic recovery bringingimproved consumer confidence.

Health CareWe see 2013 as likely to be a rela-

tively uneventful year compared to thetumultuous past two years and to2014, when it is anticipated as manyas 29 million currently uninsuredAmericans will join the health insur-ance system.

Although we expect pharmaceuticalsales growth to be challenging in 2013as additional drugs go off-patent, wedon’t anticipate the large declines wit-nessed in 2012. On the flip-side, wesee generic drug manufacturers bene-fitting from patent expirations and welook for low double-digit sales growthfor generic drugs.

The medical device industry is chal-lenging the 2.3% excise tax that willbe applied to all U.S.-based salesbeginning in January 2013. We believethe tax is manageable and many firmswill simply implement larger priceincreases.

Industrials We believe demand for building

products will become particularlyrobust in 2013. We see repair andremodeling markets rebounding, withthe rebuilding from Hurricane Sandyfurther boosting home repair spendingover the coming year. In addition, newhousing starts have started to pick upfrom their depressed levels of recentyears, and should soon start to boostbuilding products markets.

We expect airlines to benefit fromstrong pricing power in 2013. We thinkthere is pent up demand for both cor-porate and leisure travel, and that abetter economy will keep planes full atfares that are favorable to the airlines.Moreover, we think energy prices will

be low enough to allow solid profitabil-ity for airlines.

We see logistics companies record-ing volume growth in both the U.S. andforeign markets, and we expect a shifttowards faster, higher-priced deliverymethods as the economy improves.We think that UPS’s (UPS 73.35★★★★) planned $6.8 billion purchaseof TNT Express will go through despitechallenges by EU regulators, and thatFedEx (FDX 89.71 ★★★★★) willrespond with acquisitions of smallerpackage delivery companies in Europe.

Information TechnologyWe think the semiconductor equip-

ment industry is nearing a sequentialtrough in orders, and anticipateimproving demand trends in the firsthalf of 2013. However, we still thinkindustry sales will fall by about 5% to10% during the year. We forecast PCshipments will decline by at least 3%in 2013, as demand for tablets rises.As for tablets, we expect to witnessgrowth of 30% to 40% in the comingyear.

We think Apple (AAPL 529.69★★★★★) will more specifically pursueemerging market opportunities, withefforts that could include an alliancewith China Mobile (CHL 57.06 ★★★)and/or a lower-priced iPhone. We thinkGoogle (GOOG 702.70 ★★★) will makea large strategic move, via internalinvestment or acquisition, focused one-commerce and/or payments. Webelieve Microsoft (MSFT 27.11 ★★★)will generate some success in themobile category in 2013, as the adop-tion of Windows 8 slowly progresses.We expect Microsoft’s greatest suc-cess in 2013 to be in tablets and see apossibility the company also developsits own smartphone. While Apple andGoogle are likely to still dominate themobile operating system space in2013, Microsoft should see notableshare gain, albeit from low levels.

MaterialsWe see gold prices rising in 2013,

and even with flat production in 2013,overall we’re expecting solid earningsper share (EPS) growth from goldminers.

Paper and forest product companiesshould turn in a nice 2013. Lumberand panel prices are up, and paperpackaging prices rose in October forthe first time after two years.

Steel producers can expect a rela-tively weak year in 2013. While manysteel producers have tried to raiseprices in recent months, the pricehikes are not taking, due in part todomestic overcapacity.

Telecommunication ServicesWe predict further wireless consoli-

dation in 2013, with further smallerdeals as well as spectrum sales andswaps. We believe Sprint Nextel (S5.64 ★★★★) could be a further con-solidator once its deal with Softbankcloses.

We believe regional carriers such asLeap Wireless (LEAP 6.75 ★★★★)could look to sell excess spectrumand underperforming markets inorder to maximize their earningpotential and raise cash to pay downdebt and build out advanced LTE net-works.

We believe the increased adoptionof smartphones will also result in asharp spike in data usage as the LTEsmartphones will be more conduciveto downloading and accessing video.We believe companies such asQualcom (QCOM 62.76 ★★★★★) andthe tower providers includingAmerican Tower (AMT 76.09 ★★★★),Crown Castle International (CCI 70.48★★★★★) and SBA Communications(SBAC 69.06 ★★★★) will benefit fromthis trend.


(Continued on page 10)

What to Look for in 2013 (Continued)

Money flooded into taxable bondmutual funds again in 2012, a trendthat has been underway for severalyears now. While equity mutualfunds have experienced outflows,hurt we think by a focus on incomegeneration and competition fromlower cost ETF alternatives,investors still sought out new bondstrategies and, in general, taxable

bondmutualfunds hada goodyear. Forthe year to

date through November 2012, tax-able bond mutual funds posted atotal return of 7.7%, up from 4.4%in 2011. As investors look to 2013,when interest rates are expected toremain low, it’s tempting to jumpinto one of this year’s top perform-ing funds, but not all of this year’swinning funds earn a top rankingfrom S&P Capital IQ.

In ranking bond funds, ourapproach uses a combination ofrelative performance metricstogether with other important traitsabout the portfolio. We want to pro-vide perspective on the risk beingincurred, either through duration

(interest rate sensitivity) or creditquality, to generate yield. In 2012,we have seen yields come downamid strong demand. As such,some of the better performingfunds in 2012 do not receive a five-star ranking because of their weak-ened risk/reward profile. Additionalranking inputs include cost factors,the most prominent being a fund’sexpense ratio. In light of currentlylow interest rates and competitionfrom a growing number ofexchange trade fund (ETF) alterna-tives (see page 11 for moredetails), we highlight two taxablebond mutual funds that earn a five-star ranking, have had relative suc-cess thus far in 2012, and incur anexpense ratio of less than 0.50%.

TCW Total Return Bond Fund This strongly performing diversi-

fied bond fund (TGLMX 10.33★★★★★) owns a mix of mortgage,asset-backed, and U.S. Treasurybonds and keeps duration wellunder control, according to ourresearch. The fund was up 12.4%for the year through November,making it the best performing fundin its peer group, an accolade itjust barely missed in calendar 2010

when it was the third best in agroup of 85 funds. The fund’srecent 30-day SEC yield of 3.93%,well above the 1.73% peer average,stems in part from taking on somecredit risk as 21% of assets were inbonds with credit ratings of B orbelow. However, half of the fund’sassets were in AAA or AA-ratedbonds. The expense ratio is a modest 0.44%.

Vanguard Long-Term Investment Grade Fund

Posting the same 12.4% year todate gain, this fund (VWESX 10.95★★★★★) has been having a goodyear also after besting its peers in2010 and 2011 as well. As thename suggests, it takes on greaterduration risk than the averagebond fund, but holds securitieswith mostly investment-gradecredit ratings; as of September2012, 53% of assets were in bondsrated A and 25% in bonds rated AA.In contrast to the TCW fund, 71%of the assets were in U.S. corporatebonds and 8% were in foreign cor-porate bonds, with just 19% in U.S.government or agency bonds. Itsrecent yield was 3.97%. Theexpense ratio is just 0.20%. ■

ANNUALFORECAST

2013


Yield: It’s Still in FashionTwo funds with low costs that have fared well in 2012.

Todd RosenbluthS&P Capital IQ

Fund Analyst

FUNDSTRATEGIES

UtilitiesWe believe Exelon (EXC 29.68

★★★) will reduce its dividend in2013. Exelon could reduce its divi-dend by $0.70 (33%) to $1.40, andstill have a yield of around 4.7%,above the 4.4% current peer average.

We expect to see EdisonInternational (EIX 44.49 ★★★)deconsolidate its Edison Missionsubsidiary following its anticipatedbankruptcy filing. EdisonInternational’s earnings would thenreflect only the regulated Southern

California Edison and the holdingcompany.

We believe ITC (ITC 78.09 ★★★★★)will successfully acquire Entergy’s(ETR 63.57 ★★★) transmissionsystem, making ITC the largest U.S.power transmission company. ■

What to Look for in 2013 (Continued from page 9)


It’s been a busy 2012 for theexchange traded fund (ETF) industry.As more assets flow into both equityand fixed income funds, new ETFshave been launched. At the sametime, however, some funds haven’tfared so well, with several fundseither closing or cutting expenseratios to attract more assets.

Before we offer some predictionsfor the year ahead, we want to providesome perspective on the industry.Investors had $1.45 trillion in assetsheld in U.S. exchange traded productsat the end of November. S&P CapitalIQ had data on 1,276 exchange tradedproducts available at the end ofNovember, compared with 707 threeyears ago. New ETFs keep coming tomarket and within equity funds we’veseen a focus on emerging marketproducts. As for fixed income, newactive and credit-quality focused ETFsgained traction in 2012.

This has been the year of theexpense ratio cut. While we thinkinvestors should look at more than anETF’s expense ratio before making apurchase, the ETF industry has beenacting recently as if cost is all thatmatters. In October 2012, the largest

ETF provider iShares announcedexpense ratio reductions for six of itsETFs, including the iShares Core S&P500 Index. This came on the heels ofCharles Schwab’s September 2012cutting of expense ratios on all 15 ofits ETFs, including Schwab US LargeCap ETF. PowerShares has since fol-lowed with its own expense ratio cutsand even famously low-costVanguard has positioned itself for afurther reduction in 2013, withannouncements of new benchmarksfor many of its widely known ETFssuch as its Vanguard EmergingMarkets Stock Index Fund.

While many forecasts for 2013 aretied to the state of the U.S. economyand the resolution of the “fiscal cliff”issues in Congress, S&P Capital IQbelieves the ETF industry will gathermore assets again in 2013.

One such prediction we have isthat diversified international andemerging market funds will garnerfurther attention as investors seekout low-cost, diversified ways to takeon added risk in hopes of achievinghigher returns. Alec Young, S&PCapital IQ global equity strategist,notes that consensus estimates call

for emerging market economiessuch as China, Mexico, Russia, andTurkey to exhibit relatively strongeconomic growth in 2013. The addi-tion of new, low cost ETFs such asiShares Core MSCI Emerging MarketsETF and PowerShares S&P EmergingMarkets Low Volatility Portfolio addsmore options for investors. We thinkthese portfolios offer competition toVanguard Emerging Markets StockIndex Fund.

We also predict money will flowinto fixed income ETF at rapid pace,as investors hunt for yield. ThroughNovember, PIMCO Total Return ETF,an actively managed fixed incomeETF that follows a strategy similarto the mutual fund with the samename, gathered $3.7 billion inassets despite only launching inMarch. SPDR Barclays Capital ShortTerm High Yield Bond added morethan $500 million in just ninemonths. With the 10-year Treasuryyield likely to remain below 2% in2013, we think investors will seethe benefits of these ETFs and oth-ers such as iShares Core Total U.S.Bond Market and Vanguard TotalBond Market Index Fund. ■

More Money for ETFs in 2013We see no letup in the flow of money into both equity and fixed income funds.

Todd RosenbluthS&P Capital IQ

Fund Analyst

ETFs in Focus for 2013

ETFSTRATEGIES

S&P CURRENT YIELD INCEPTION EXPENSE ASSETSFUND NAME / TICKER RANKING PRICE (%) DATE HOLDINGS RATIO (%) ($ MLNS)

iShares Core MSCI Emerging Market ETF / IEMG NR $50.55 2.55 10/18/2012 1,637 0.18 136iShares Core S&P 500 / IVV OW $143.26 1.99 5/15/2000 503 0.07 34,126iShares Core Total U.S. Bond Market / AGG NR $111.15 2.38 9/22/2003 1,706 0.08 15,442Powershares S&P EM Low Volatility Port. / EELV NR $28.20 2.38 1/13/2012 200 0.29 87Pimco Total Return ETF / BOND NR $108.92 2.22 2/29/2012 842 0.55 3,875Schwab US Large-Cap ETF / SCHX OW $33.93 1.90 10/30/2009 748 0.04 985SPDR Barclays Short Term High Yield Bond ETF / SJNK NR $30.56 4.50 3/14/2012 339 0.40 553Vanguard Emerging Markets Stock Index Fund / VWO OW $43.51 3.39 3/4/2005 885 0.20 58,800Vanguard Total Bond Market Index Fund / BND NR $84.49 2.71 4/3/2007 5,391 0.10 17,757

Data through 12/13/12. Source: S&P Capital IQ. NR = Not ranked. OW = Overweight.


Investment pros frequently use theS&P 500 as a benchmark when con-structing a diversified portfolio. The500, which is market-value weighted,includes 10 sectors and more than100 industry groups. Each stock’sweighting in the index is determinedby multiplying the number of sharesoutstanding by the current shareprice.

The sample portfolio below is broad-ly representative of the S&P 500,though we also included some mid-and small-cap names for capitaliza-tion diversification purposes. Weadjusted the sector weightings toreflect S&P’s investment policy andeconomic projections, so we expectthe 20-stock list (composed entirelyof stocks ranked 4- and 5-STARS) to

outperform the index in the comingyear. (Following the sector name in thetable, the first figure in parenthesesrepresents the sector’s approximateweighting in the S&P 500; the secondfigure is our suggested weighting.)

Choices from The Outlook’s MasterLists were used wherever possible.Performance of the portfolio is nottracked. ■

Building a Well-Balanced PortfolioThis portfolio affords diversification among major industry groups.

PORTFOLIO BASED ON SUGGESTED SECTOR WEIGHTINGSSECTOR 12-MONTH

(% OF S&P 500, CURRENT ANNUAL YIELD †P/E TARGETSHARES SUGGESTED % WEIGHTING) ‡STARS RANKING *RISK STYLE PRICE COST INCOME (%) RATIO PRICE

CONSUMER DISCRETIONARY (12%, 13%)130 ¬ Disney / DIS 5 A+ Medium L-Growth 50 6,500 98 1.5 14.9 57105 ¬ Target / TGT 5 A- Medium L-Growth 62 6,510 151 2.3 14.3 80CONSUMER STAPLES (11%, 11%)145 ¬ Coca-Cola / KO 5 A+ Low L-Growth 38 5,510 148 2.7 18.8 4475 Wal-Mart Stores / WMT 4 A+ Low L-Blend 72 5,400 119 2.2 14.6 80ENERGY (11%, 11%)50 ¬ Chevron / CVX 5 A+ Low L-Blend 107 5,350 180 3.3 8.5 13260 ¬ ExxonMobil / XOM 5 A+ Low L-Blend 89 5,340 137 2.5 11.2 103FINANCIAL SERVICES (15%, 15%)65 Chubb / CB 4 A Medium L-Blend 77 5,005 107 2.1 15.1 87110 State Street / STT 4 B+ Medium L-Growth 45 4,950 106 2.1 11.6 5075 ¬ T. Rowe Price Group / TROW 5 A- Medium L-Growth 65 4,875 102 2.1 19.6 74HEALTH CARE (12%, 13%)95 Humana / HUM 5 B+ Medium L-Growth 68 6,460 99 1.5 8.9 9065 ¬ McKesson / MCK 5 A- Medium L-Blend 97 6,305 52 0.8 13.1 107INDUSTRIALS (10%, 11%)130 ¬ Fastenal / FAST 5 A Medium L-Growth 43 5,590 109 1.9 29.0 60365 Kelly Services / KELYA 5 B- Medium S-Value 15 5,475 73 1.3 10.1 21INFORMATION TECHNOLOGY (19%, 19%)10 Apple / AAPL 5 B+ High L-Growth 545 5,450 106 2.0 12.0 70025 ¬ Int’l Business Machines / IBM 4 A+ Medium L-Growth 194 4,850 85 1.7 12.7 227240 ¬ Microsemi / MSCC 4 B- High S-Blend 21 5,040 0 Nil 9.0 24185 ¬ Microsoft / MSFT 5 A- Medium L-Growth 27 4,995 170 3.4 14.6 37MATERIALS (4%, 3%)50 Reliance Steel & Aluminum / RS 5 A- Medium M-Blend 58 2,900 50 1.7 11.0 65TELECOM SERVICES (3%, 3%)375 ¬ Windstream / WIN 5 NR Medium L-Value 8 3,000 375 11.9 15.0 12UTILITIES (3%, 1%)20 ¬ Oneok / OKE 5 A- Medium L-Value 44 880 26 3.0 24.5 55Total 100,385 2,293 2.3

¬ Master List issue. *Based on our analysts' assessment of qualitative factors, including financial strength, potential share volatility, competitive position, industry cyclicality, reg-ulatory/legal issues, and other factors. Please note that all investments carry risks. ‡See definitions on page 2. †Based on S&P estimated fiscal 2012 earnings. L-Large cap. M-Mid cap. S-Small cap.

ANNUALFORECAST

2013

THE OUTLOOKINTELLIGENCE FOR THE INDIVIDUAL INVESTOR

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