We recently sat down with our strategist team to get an update from them on their outlook for the markets and the economy for the remainder of 2012 – and how that outlook stacks up against the one they published at the beginning of 2012 .
For the most part, the team’s expectations have played out. Markets have remained volatile, modest profit growth has won out, Europe has continued to dominate negative headlines, China’s economy has slowed but avoided a hard-landing.1 Our strategists have made a few revisions to their original annual outlook, though. Specifically, the team has:
- Reduced the U.S. real GDP year-on-year growth forecast to 2.1% (down from 2.5%), reflecting the weaker-than-anticipated outcomes for GDP and employment in the second quarter of 2012. Their lowered U.S. economic growth expectations notwithstanding, our strategist team still sees a U.S. recession as unlikely. However, they project this pace of GDP growth will not be enough to make meaningful inroads into unemployment rates and expect that the Federal Reserve will probably initiate a third round of quantitative easing (QE3) in either the fourth quarter of 2012 or the first quarter of 2013.
- Reduced the expectation for 10-year Treasury yield at year end to 1.8% (down from forecasts of between 2.5% to 2.75%), given that the yield has declined more in response to weaker growth, subdued inflation expectations and safe haven appeal, than our strategists anticipated. The team now projects yields will rise modestly by year-end. They believe a significant sell-off seems unlikely, however, while markets continue to anticipate that the Fed funds rates will stay near zero for an extended period.
- Increased the year-end target for the Russell 1000® Index and the S&P 500 Index® to 760 (up from 720) and 1375 (up from 1300), respectively. If their forecast comes to pass, it would mean a 9% price return for the calendar-year 2012 and, with dividends added, a total return of just over 11%. This change in the forecast reflects better-than-expected corporate profit performance despite weaker-than-expected economic growth. However, the new target remains below the levels of 1400 achieved in early August, implying that our strategists see some downside risks over the remainder of 2012, even though the volatility so far in 2012 suggests a wide range of potential outcomes.
Russell’s investment strategists see three reasons for expecting a modest pull-back from August peaks. The first is that their various valuation models now signal that U.S. equities are fully valued with some pointing to a degree of overvaluation. The second is that corporate profits are likely to come under increased pressure going forward, given the sluggish pace of U.S. economic growth. Eventually profit growth, they believe, has to align with nominal GDP growth, and that adjustment might be more abrupt than previously thought. The third reason is that the U.S. market is currently in another ‘risk-on’ phase, as markets applaud the Europe Central Bank president Mario Draghi’s “whatever it takes” comments. One lesson of 2012 so far has been to remain skeptical about market mood swings between pessimism and optimism.
The so-called “Fiscal cliff”
Aside from events in Europe, Russell’s investment strategists project the main downside risk to the U.S. economy is the so-called “fiscal cliff” in early 2013, when temporary tax reductions and deduction benefits expire and mandated spending cuts are enacted.2 However, they count on a central scenario in which a deal will be reached to limit the fiscal tightening to around 1.5% of GDP. However, the strategists expect that the uncertainty leading up to a resolution likely will be destabilizing both for equity markets, business in general and consumer confidence.
To hear more about our strategists’ perspectives, view a brief video interview.
1A soft landing in the business cycle is the process of an economy shifting from growth to slow-growth to potentially flat, as it approaches but avoids a recession. It is usually caused by government attempts to slow down inflation. The criteria for distinguishing between a hard and soft landing are numerous and subjective.
2“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012. U.S. lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market.The Russell 1000®Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are reflected.
The S&P 500 measures a basket of 500 stocks considered to be widely held and is meant to reflect the risk/return characteristics of the U.S. large cap universe. It is a market value weighted index that selects its companies based upon their market size, liquidity, and sector.
Indexes are unmanaged and cannot be invested in directly.