Call it the Band-Aid economy.
Indefinite low interest rates. A two-month extension on looming spending cuts and tax increases. A suspension of the $16.4 trillion debt ceiling to avoid a government default.
It’s enough to make a stock picker head to the sidelines in 2013. But with fixed-income investments paying next to nothing, local stock experts say investors may want to get aboard the slow-growth train this year.
"I’m more optimistic about the early part of 2013, as the fiscal cliff was averted by the Congress and White House, albeit temporarily," said Dwight Melton, who chalked up an impressive 49.9 percent return last year, versus a 16 percent return from the S&P 500 stock index, to win the Star-Advertiser’s annual investment contest. "Mandatory tax hikes and spending cuts are still on the horizon. This uncertainty will cause business and consumer spending to slow in the near future."
Still, the market could move "modestly higher" this year, added Melton, a four-time contest champion and co-founder of the Hawaii Stocks and Options Group.
Melton is joined for this year’s 12th annual contest by three-time champion Barry Hyman (up 19.9 percent in 2012), vice president, private client group, for the Maui branch of FIM Group Ltd.; Richard Dole (up 15 percent), CEO of Honolulu-based investment bank Dole Capital LLC; and Norm Caris (down 1.6 percent), a Kauai resident and managing director of Los Angeles-based investment bank B. Riley Caris. Contest rules allow participants to change their hypothetical $20,000 portfolios at the end of each quarter.
Caris, who won the investment contest in 2008, also sees some growth in the market.
"The market will likely close 5 to 10 percent higher on the year, given the backdrop of easy money from the Fed, continued massive liquidity and somewhat negative sentiment," Caris said. "All are often key elements that presage a rally in equity markets."
Hyman said at some point central banks around the world will have to raise interest rates, but doing that could cause a shock to economies.
"The Fed is pushing on a string by keeping rates near zero," Hyman said. "Keeping rates low is an artificial stimulant to the economy. Just as people who can go a few days running on coffee, sugar and other stimulants eventually need a good nap, low rates only delay the need for the economy to properly heal itself. Hard work, prudent regulations, appropriate spending, reasonable taxes and time are going to heal our economy — not low rates."
Melton, who had great success with index funds last year, is sticking with the same strategy and singles out financials and small caps as his two favorite sectors. The index funds he selected for the first quarter triple the performances of the indexes they track — in this case the Russell 1000 Financial Services Index, the Nasdaq 100 Index, the Standard & Poor’s 500 Index and the Russell 2000 (small cap) Index. All four of the index funds had returns greater than 40 percent last year, with the Direxion Financial Bull 3X leading the way with an 84.9 percent gain.
Hyman, whose picks are more globally oriented than any of the contest participants, selected three companies whose headquarters are based outside the U.S.
Hutchison Port Holdings Trust is a Singaporean-based port investor, developer and operator that also is involved in transportation-related services. The stock is thinly traded, though, and sells for less than $1. Groupe Bruxelles Lambert S.A., headquartered in Brussels, is a holding company with interests in energy, media and utility companies. Toronto-based Brookfield Real Estate Services Inc. operates a network of residential and real estate brokers in Canada, the U.S. and Portugal.
His other picks are software giant Microsoft and Gaiam, a provider of health and fitness products.
Despite the three major indexes finishing 2012 in what Hyman calls "fully valued territory," he expects the Dow to rise 14.5 percent this year and finish at an all-time high of 15,000, with the S&P 500 increasing 12.2 percent to 1,600 and the Nasdaq growing 9.3 percent to 3,300. Hyman says the indexes were fully valued at the start of this year because their long-term price/earnings ratios were above historic averages, U.S. economic growth was below average and dividend yields were low at 2.6 percent, 2.2 percent and 1.5 percent, respectively. As stock prices rise, dividend yields decrease.
"But with fixed-income yields even lower, I suspect investors will continue to chase yields, pushing the indexes to more overvalued levels, favoring the lower-growth, higher-yielding Dow over the highest-growth but lowest-yielding Nasdaq," Hyman said. "At some point the market will wake up and realize the index- and exchange-traded fund-driven rush into popular stocks has, like the indexing craze did in the 1990s, driven prices on those investments to levels well above levels supported by fundamentals. I would expect a significant correction of their prices at that point. But until then the party will likely rage on."
Hyman said the inflection point could come when central banks reverse course and begin raising rates.
"If that comes in 2013, all bets on these forecasts are off," he said. "To avoid bearing the brunt of such an inevitable correction, investors would be well served to avoid most ETFs and index leading stocks and favor investments chosen from a global perspective with solid balance sheets, strong cash flow, good competitive positioning and only those whose prices are low relative to their real earnings, asset values and other measures of value."
Dole, the 2011 contest champion, is mostly staying the course for the first quarter by holding onto four of the picks he had at the end of 2012, but he did add one new investment: Facebook.
"This stock sold higher as a private company than as a public one," Dole said. "Investors prefer the liquidity of a public trading market. Now that most of the disappointed IPO investors are out, the stock has promise."
The much-ballyhooed initial public offering of Facebook last year turned out to be a bust as the stock fell as low as $17.73 from its IPO price of $38. But investors gradually have been taking another look at the company, which finished 2012 down 29.9 percent at $26.62.
Dole’s holdover investments are local bank Territorial Bancorp, diversified manufacturer General Electric, scientific and technical instruments provider Newport and public utility holding company Exelon.
Caris is most revved up about Ford among his picks.
"Not only is it a great company in and of itself, but also part of a meaningful secular (long-term) story," he said.
"We are on the verge of a major vehicle upgrade cycle, as the average age of trucks on the road is now 12 years, and purchases delayed by a sluggish economy are now coming online."
