Investors: Don’t be fooled by the apparent weakness in the economy both in the United States and abroad. According to top chief investment strategists who presented their 2012 outlooks in New York last week, corporate earnings are at an all-time high, and the smart money is positioning investments for growth next year.
During the 2008 financial crisis, publicly traded companies saw the commercial paper markets seize up, which froze their access to short-term lending, and the lesson they learned was to rely on themselves rather than the credit markets for their cash needs. Now, U.S. companies’ cash reserves are at their highest point since 1954, said Jim Swanson, chief investment strategist for MFS Investments.
As a result, Swanson said, cash-rich companies are well poised to spend their money on dividends, buybacks and capital expenditures—all good things for investors. “This business cycle is not as weak as people portray it,” he said.
ING Investment Management Chief Investment Officer Paul Zemsky agrees, pointing out that third-quarter 2011 earnings were at a historic high, with two-thirds of U.S. companies reporting earnings surprises to the upside.
“There are earnings surprises because companies are reluctant to be optimistic,” Zemsky said, noting that the overall economy is in better shape than many surmise. “We’re not going to have a recession in 2012. It just doesn’t look like it’s going to happen.”
The strategists at MFS and ING both advise positioning portfolios for growth next year. Where should investors allocate their assets? Here are the MFS and ING strategists’ top investment picks for 2012:
1) The Technology Sector
Technology is a new defensive sector, Swanson asserts, pointing to tech companies’ free cash-flow margins of nearly 20% today versus only about 5% in 2001. Product revolutions in this sector are frequent, and easily exportable to countries such as China, whose growing middle class has a high demand for the newest smartphones and tablets. While Swanson didn’t name names—Apple, anyone?—a day before he gave his thumbs-up to tech, Warren Buffett revealed to CNBC that he had bought $10.7 billion of IBM stock.
2) Mid-Cap Stocks
ING Chief Market Strategist Douglas Coté, an admitted market bull, likes mid-caps in his current quest to advocate a greater focus on fundamentals. Pointing to companies’ record third-quarter revenues—north of 12% for the S&P 500 versus the more typical 8% to 9% quarterly sales growth—Coté predicts fundamentals will continue their march forward in 2012. He supports this argument with the evidence of accelerating corporate profits, “booming” U.S. manufacturing, underestimated consumer strength and the emergence of middle-class consumers in developing nations.
“Investors need to position themselves for when the rallies come,” Coté says. The S&P MidCap 400, an index that provides investors with a benchmark for mid-sized companies, lists Dollar Tree Inc., Green Mountain Coffee Roasters and Kansas City Southern among its top 10 constituents by market cap.
3) Dividend-Paying Stocks
Dividend payers, like Duke Energy, are another “new defensive” sector, according to Swanson. Experiencing a dramatically V-shaped profit recovery in the current cycle, S&P 500 companies’ cash flows are at an all-time high, which promises dividends from quality stocks, he says. “Since 1999, companies have been addressing balance sheet concerns and deleveraging,” which should put higher dividends in investors’ hands, Swanson predicts.
4) High-Yield Credit
Next year will be a good one for high-yield credit, says Christine Hurtsellers, chief investment officer for fixed income at ING. MFS Portfolio Manager Erik Weisman agrees, noting that high-yield bond valuations showed a 718 basis point yield premium over U.S. Treasuries as of Oct. 31. The fundamentals of high-yield corporate look appealing, with low default rates expected to continue, says Hurtsellers, who favors single B-rated credits.
Separately, Neuberger Berman's high-yield fixed income team reported last month that de-risking by banks is the primary source of selling pressure in the space, and that current high-yield valuations look attractive relative to fundamentals with market yields approaching 10%. The Neuberger Berman High Income Bond Fund (NHINX), which is rated five stars by Morningstar and is ranked in the second percentile of the high-yield bond category over five years, has a current yield of 7.08%.
5) Emerging Markets
Adding to her fixed-income outlook, Hurtsellers says that emerging-market sovereign issues are poised to do well, especially in Latin America given the demand for commodities, “and selected emerging-market corporates also present good values and opportunity.” Her optimism on EM compares to Europe, where Italian yields above 7% are a reason for concern. Coté also likes emerging markets. “Don’t get confused by the noise emanating out of Europe,” he says. “There’s no other market like the EMs for 10-year performance.”
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