A safe route around the "fiscal cliff" continues to elude Congress and the White House. A recession is possible if automatic tax increases and spending cuts begin to take effect on Jan. 1, and people are afraid. Consumer confidence fell for a second straight month in December.
In such an uncertain environment, stock mutual fund managers acknowledge there's reason for investors to be unusually cautious in making any short-term moves. But they remain optimistic that there will be significant rewards for staying invested in stocks. They expect the market to climb in 2013, although the gain is likely to be more modest than this year's 15 percent return in the Standard & Poor's 500 index through Thursday.
The reason for their optimism is that corporate profits remain strong. They say that's the key factor in assessing the outlook for stocks, rather than the plodding economic recovery, political battles in Washington or the gloomy outlook of consumers.
Earnings have recently grown at a much slower pace than in 2011. But they're still increasing, with Wall Street analysts expecting growth of about 9.9 percent in 2013 on average, according to a recent survey by FactSet.
"The bright spot in this slow economic recovery has been corporate profits," says Mike McGarr, co-manager of Becker Value Equity fund (BVEFX), which has posted an average annualized return of 2.2 percent over the latest 5-year period, outperforming nearly nine of 10 of its peers. He expects stocks to deliver "reasonably good results, although we've been steering people's expectations down lately."
Stocks remain modestly inexpensive, based on their price-earnings ratios — a measure that shows investors how much they're paying for a dollar in earnings. The S&P 500 recently has traded at around 14 times the amount that companies earned per share over the past 12 months. That's below the 10-year average of about 15.
That's a key indicator that stocks might climb higher. Here are the views of three fund managers:
EXPECT MODEST GAINS
McGarr predicts stocks will return around 5 to 6 percent in 2013, modestly below the 9 percent returns that the market has averaged historically. Yet he expects volatility to rise as investors assess continuing efforts in Washington to fix the nation's fiscal problems.
If his prediction turns out to be correct, the return of the stock market would surpass the returns that investors have recently earned from lower-risk investments, such as most categories of bonds. For example, a diversified bond index has returned 4.1 percent this year, with an index of government bonds returning just 1.9 percent.
McGarr isn't predicting a breakout year for stocks because U.S.-based companies remain concerned about slow economic growth overseas, as well as at home.
"They're talking about slowing orders from big overseas customers, in Europe in particular," he says. "And China's growth outlook continues to be a wild card — some think its growth is still slowing, while some think we may have seen the worst of the slowdown."
PLAY IT SAFE
Peter Tuz, co-manager of the Chase Growth and Chase Mid Cap Growth funds (CHASX, rated 3 stars by Morningstar, and CHAMX, with 4 stars out of a possible 5), says fiscal cliff uncertainties are likely to hurt short-term stock returns.
"If there isn't a deal soon, I expect weakness, because markets hate uncertainty," Tuz says.
Asked what an investor might do in the short-term, he urged caution: "If a person were thinking about investing when the market opens on Jan. 2, I would partially defer that decision, and spread the investment out over the course of three to six months. That's because there will be lots of uncertainty, and you'll be able to take advantage of certain dips in the market that we'll inevitably see."
For the full year, Tuz expects a modest gain for the stock market of 5 to 7 percent: "That's reasonable, given the uncertainty we face."
SEIZE THE OPPORTUNITY
John Buckingham, manager of two 3-star funds, Al Frank (VALUX) and Al Frank Dividend Value (VALDX), is optimistic about dividend-paying stocks, citing the abundant cash reserves that many companies have now.
He maintains that outlook despite the likelihood that tax rates on dividend income will rise sharply starting in January for investors in the top tax brackets. That's the outcome if no deal is reached in the fiscal cliff talks by Monday. A dividend tax increase could also be included in any agreement that's reached.
"Clearly, what's going to be more important to the market than higher dividend taxes is the health of corporate profits, and the economy," Buckingham says.
Investors clearly remain nervous, as withdrawals from stock funds have consistently exceeded deposits this year. Yet Buckingham sees that as an opportunity, concluding that investors' fears are a key reason why stocks are priced inexpensively. He wouldn't be surprised to see the market return 9 to 12 percent next year.
"The pendulum will always swing between fear and greed," he says. "And we've swung way too far toward fear in recent years."
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