Stock-Market Outlook For 2012

12/19/2011


Staking your portfolio on the predictions of experts is typically a mistake. But it helps to know where your views differ from the consensus, and year-end is a convenient time to make comparisons. We see at least four areas where the conventional wisdom regarding 2012 may be off.

Conventional wisdom: Stocks are going nowhere fast. While every market has extreme bears and extreme bulls, our sense is that many investors would be surprised by an upside breakout. Yet the Dow Industrials and Dow Transports are within 5% of four-month highs and within 20% of all-time highs. With closes above the respective October highs of 12,231.11 and 5,025.09, the market's primary trend would be regarded as bullish under the Dow Theory. In the near term, a close above the Oct. 28 high of 1,285.09 in the S&P 500 Index would likely trigger performance anxiety among fund managers holding too much cash.

---------------------------- Trailing Price/Earnings Ratio ----------------------------
---------------------------- Between ----------------------------
0 And 6
6 And 8
8 And 10
10 And 12
12 And 14
14 And 16
16 And 18
18 And 20
20 And 75
Above
75
Negative
Or NA
Recent number of S&P 500 stocks 
11
25
41
59
60
85
56
30
102
11
19
Average number since Jan. 1990
6
13
25
37
48
53
48
41
161
18
51
High since Jan. 1990
81
78
84
82
81
86
81
72
265
44
105
Low since Jan. 1990
0
0
5
7
12
19
15
10
31
3
15
% of month-ends below recent number
90
91
87
92
79
99
70
21
11
25
3
Avg. 12-mo. return for stocks in P/E range (%)
22
19
15
13
13
12
12
11
11
10
14

Conventional wisdom: The U.S. economy faces a tough slog next year. Consensus estimates project just 2.2% growth in U.S. gross domestic product (GDP) in 2012. But, as we write on page 8, rising personal consumption and consumer confidence suggest expectations for the U.S. economy may be unduly low if job growth remains positive.

Conventional wisdom: Consensus forecasts for U.S. corporate profits are too optimistic. With U.S. corporate profit margins at all-time highs, investors seem skeptical of consensus forecasts calling for 10.5% growth in S&P 500 Index profits next year. But net profit margins are being helped by low interest expense, a trend likely to continue, and operating margins are well below prior peak levels. While we expect profit growth to slow, we are still finding attractively valued stocks supported by solid operating momentum and attractive profit-growth prospects.

Conventional wisdom: The European debt crisis represents the biggest foreign threat to stocks. With U.S. stocks lurching back and forth based on the latest headline from Europe, anxiety about the Continent's debt crisis is understandable — and justified. But consensus forecasts already project a recession for Europe in 2012, and we expect the fiscal and monetary authorities to do what's necessary to avoid a disorderly default by a eurozone member. Meanwhile, expectations for China's economy have only begun to deteriorate, with consensus forecasts projecting 8.4% GDP growth — down from the 9.1% expected for this year. With the materials, energy, and industrials sectors hugely dependent on robust growth in Asia, a harder-than-expected landing for China would be very bad news.

Our advice

While we think stocks look fairly cheap and we are cautiously optimistic regarding the 2012 profit outlook, we'd like to see confirmation from the market averages before committing too much more of our cash reserves. As a partial hedge, our buy lists have 21% to 22% in Vanguard Short-Term Investment-Grade ($10.63; VFSTX), a short-term bond fund with a 1.9% yield.


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