Market Outlook for the Rest of 2012: Positive

Here's a look at what chief investment officers are putting in their midyear reports.

By Robert Powell

It's that time of year when chief investment officers from firms big and small start churning out their midyear reports, reflecting on the half year that was and predicting what might happen in the half year that's about to begin. What can we glean from these reports? What course adjustments might we make to our investment ship?

Well, here's a look at what's crossing the transom.

Investors, pundits say, will face more challenges in the second half of the year than they have in the first half. The markets are likely to remain "on edge" throughout the remainder of 2012, Russ Koesterich, the global chief Investment strategist for BlackRock's iShares business.

Others share that sentiment. Stuart Freeman, the chief equity strategist at Wells Fargo Advisors, said in his midyear report that the markets will be "choppy" for the rest of 2012

But even with "rocky," and "choppy" markets, advisers also think that the outlook for U.S. stocks is positive through the end of the year.

James Swanson, chief investment strategist at MFS Investment Management, for instance, said in a recent conference call that there are reasons to be optimistic. One, the drivers of the current business cycle are positive. Corporate profit margins, consumer spending, the housing market, and car sales are all rising, from his perspective.

Freeman also said the market has the potential to move higher -- it's the second leg of this cyclical bull market. He predicted in Wells Fargo's 2012 Midyear Economic and Market Outlook report that the operating earnings of the Standard & Poor's 500 index will rise 6% to 7% and he's looking for the S&P 500 to close the year between 1,400 and 1,450. His rationale for that forecast: Job growth, consumer confidence, a resilient U.S. economy, and increased liquidity world-wide all bode well for stocks.


GDP at 2%

As for the economy, Swanson noted that economic expansions since World War II have lasted on average 59 months -- nearly five years. The current economic expansion is at 35 months, which means there could be another two years of expansion. "We're roughly halfway or in midcycle here, not at the end of a cycle," said Swanson.

To be sure, Swanson said, this cycle of economic growth may not be up to politicians' standards of 4% growth, which was seen in the '80s and '90s, recoveries and expansions. It's just 2%. "But this 2% is organic and sustainable in that it's not being fueled by debt spending at corporate or consumer levels," he said. "Government level, yes, but the government's actually not growing in terms of payroll. So the sustainability of the cycle, to me, is intact because ... we are not witnessing a credit cycle."

Koesterich also seems to think that growth in the U.S. is unlikely to be better than 2%. But he also said potential year-end tax hikes and spending cuts in the U.S. could create more than $600 billion in "fiscal drag," or the equivalent of roughly 4% of GDP. And if the fiscal drag were to occur, Koesterich believes a double-dip recession becomes much more likely and that's not something investors are anticipating.

Europe emerges from its recession in three quarters

Europe has problems for sure. But, according to Swanson, its recession will be shallow, not nearly as deep as in 2008. Plus, the leaders of the European Central Bank have been able to keep the euro zone together in the short term with band aids and temporary solutions.

According Swanson, Europe biggest issue at the moment is not necessarily too much debt in the peripheral countries. Rather the bigger and more fundamental problem to be addressed is high-unit labor costs and labor inefficiency, he said.

"The number one problem, and it's important to understand the root cause of the problem in Europe, is a unit labor cost problem," Swanson said. "Europe has been losing its share of the world export markets for years."


China's slowing, but not crashing

According to Swanson, the Official China manufacturing employment subindex, though volatile, is as good a guide as there is to figuring out the state of the Chinese economy. And at the moment "it's holding up," Swanson said.

There are two reasons why China is holding up: First, the current slowdown is related in part to recession in Europe, but more due tight monetary policies of the People's Bank of China of a year ago. With China lowering interest rates and providing liquidity, Swanson predicts, we'll see the fruits of this in five to six months, 10 months, tops.

Second, he said, the "big threats to emerging market economies, the inflation scare, particularly in agriculture, has subsided with record crops and a return to a more normal weather patterns."  So, he predicts growth in emerging market to resume closer to trend by year-end in the major emerging market countries, such as Brazil and India.

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