MARKETS

All indications are that 2013 should follow on the heels of 2012 and continue to send big caps up, but you have to be selective and patient, notes George Putnam of The Turnaround Letter.

It looks like 2012 was a good year for investors. The S&P 500 was  up about 13% for the year, and its smaller-cap brethren are up slightly more, with the MidCap 400 gaining about 16%.

The big laggard for the year has been the Dow Jones Industrial Average, which was only up about 7%. It is unusual for the Dow’s performance to diverge from that of the S&P 500 by so much. Perhaps it is because the Dow includes a much smaller number of stocks—only 30 versus 500 for the S&P. (Another example of the benefits of diversification.)

We thought perhaps it is because the Dow is dominated by value stocks, but the Russell 1000 Value Index is up about 15%. Our best guess is that it is because of the math that underlies the Dow index.

Unlike most other indices, which are market cap-weighted (i.e. stocks with larger market capitalizations have more effect on the index), the Dow is stock price-weighted (stocks with higher prices have more effect). And it turns out that several of the highest-priced stocks in the Dow were relatively poor performers, notably IBM (IBM), Chevron (CVX), McDonald's (MCD), Caterpillar (CAT), and Exxon (XOM).

The strong performance by stocks over the past year caught many pundits by surprise. Fortunately, it didn’t catch us by surprise. In the January issue last year, we predicted that the S&P 500 would rise by 10% in 2012.

It didn’t catch most of our readers by surprise either. In the poll on our Web site at the beginning of the year, 19% of those who voted predicted that the S&P would rise more than 10% by the end of 2012, and another 36% said it would rise between 5% and 10%. Only 22% predicted that the S&P would fall.

Our other projections for 2012 had mixed results. We got it right (at least based on the S&P indices) when we said that small caps would outperform large caps. Our prediction that high-grade bonds would underperform may or may not have been right, depending on which types of high-grade bonds you look at.

And we definitely got it wrong when we said that high-yield bonds would underperform. They rolled on to another strong year, with the Merrill Lynch High Yield Master index rising 15%.

Recapping the past year is easy; what about 2013?

We remain convinced that no one can consistently predict what the market will do, and therefore making a market forecast is something of a fool’s errand. Nevertheless, we also believe that publishing a stock newsletter essentially obligates you to make a forecast.

We remain quite optimistic about the stock market for 2013. While there certainly will be a lot of negative forces on stocks in the year to come—many of them emanating out of Washington, DC—we expect stronger positive forces to drive both the economy and the stock market.

The two strongest positive forces are likely to be low energy prices and a recovery in the housing sector. Low energy prices, particularly for natural gas, will reduce costs in many industries and put money in the pockets of consumers through reduced gasoline, heating, and electricity prices. The housing recovery will not only provide jobs, but will also improve consumers’ balance sheets as home prices begin to rise.

When you put it all together, we expect the S&P 500 to gain 9% in 2013. We remain wary of high-yield bonds.

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Related Reading:

Kick the Can and Hope for Change

US Market Still a Global Leader

Moving Toward Cyclicals

Tickers Mentioned: IBM, CVX, XOM, MCD, CAT

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