Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
Note: In late January, Congress passed legislation to suspend the nation’s borrowing limit for three months, until May 19, providing more time for budget negotiations before Democrats and Republicans face another possible showdown that could affect financial markets. Top economist Allen Sinai, PhD, says that despite the showdowns, or “fiscal cliffs,” that have threatened the economy and financial markets this year, the outlook remains bright for stocks in 2013. Here is an updated version of an article appearing in the February 15, 2013, issue of Bottom Line/Personal.
The economy is still stuck in slow motion, but that won’t hold back the stock market this year.
The dramatic, late-night actions of a dysfunctional Congress in early January headed off across-the-board tax increases. Then in late January, Congress suspended the nation’s debt ceiling for three months. Those actions averted the worst of the so-called fiscal cliffs and let us sidestep a deep recession.
Despite that, the return of higher Social Security payroll taxes this year, coupled with big federal government spending cuts that will be negotiated in coming weeks, will prevent stronger economic growth.
However, I don’t expect this sluggish economic environment to prevent the stock market from achieving attractive returns for 2013. Now that much of the uncertainty over tax rates—especially rates for capital gains and dividends—has been resolved, investors will be more willing to take on risk when it comes to investments. That will be a big positive for the stock market. In addition, earnings for US companies stand to get a boost from the very recent and surprising economic resurgence in the Asia-Pacific region.
As I told Bottom Line/Personal readers in my 2013 forecast in December, the US gross domestic product (GDP)—the key measure of the nation’s economic output—will likely rise by about 2.3% for the full year. But I have raised my predictions for the stock market. I now believe that the Standard & Poor’s 500 stock index will wind up 2013 at 1,550, a 9% annual gain and close to the record high of 1,565 reached in 2007. I expect the Dow Jones Industrial Average to rise to about 14,500, up 11%.
My analysis of how the ongoing fiscal negotiations in Washington, DC, will affect the economy and your investments for the rest of this year…
By canceling the massive income tax increases that threatened to cut into the spending ability of middle-class Americans, Congress has buoyed consumer confidence, which will allow consumer spending to rise between 2% and 3% this year, enough to sustain economic growth. But we still face a challenging environment.
The return of higher Social Security withholding taxes on salaries—to 6.2% of earnings, up from 4.2%—takes about $120 billion out of the economy and will retard growth in the first half of the year. Moreover, the early January fiscal cliff compromise did little to relieve economic uncertainty for businesses or motivate them to hire more or spend on new equipment and expansion.
That’s because it didn’t resolve some of the issues that could still push the US economy lower. These issues include $110 billion in automatic spending cuts to federal government programs—cuts that were supposed to commence at the start of 2013 but were delayed for two months to March 1—and a deadline on March 27, when Republicans could seek to stop funding of the government and let it shut down to step up pressure for deep spending cuts that, in some cases, Democrats are loathe to accept.
It’s hard to guess the specifics of the budget deal that will emerge in just a few weeks. But the result surely will be some kind of fiscal restraint and austerity measures as we struggle to get the national debt and annual budget deficits in order. Unfortunately, those measures will eliminate the possibility of more vigorous economic growth (4% to 5% is the historical average for postrecession economies) for the foreseeable future.
Once the uncertainty and acrimony of this year’s budgetary debates are out of the way, I do expect a small uptick in GDP growth for the second half of 2013, perhaps at a 2.5% annualized pace. That should help shrink unemployment, which I forecast will drop to 7.3% by the end of the year from its recent rate of 7.8%.
The congressional agreement to let the maximum dividend and capital gains tax rates remain at 15% for single tax filers with annual incomes below $400,000 ($450,000 for joint filers) should motivate investors who pulled money out of the stock market last year because of tax fears to put some money back into stocks. Also, the low, single-digit percentage returns I expect from both corporate and government bonds this year should push more investors seeking higher returns into the stock market. And even though the deal raises the tax rates on dividends and capital gains to 20% for higher earners (plus a 3.8% Medicare surtax on investment income), that won’t deter them from investing in stocks.
Interestingly, the biggest change since my last forecast has nothing to do with the fiscal cliff. The economic situation in the Asia-Pacific region is markedly improving, and that will benefit S&P 500 companies, many of which get much of their earnings from overseas. China has gotten past the downturn in its economic growth and will see a significant rebound in 2013 because of the effects of previous monetary easing, an ongoing acceleration in infrastructure spending and strong consumer spending.
The Shanghai Composite stock index jumped 15% in the last month of 2012. It should continue to rise as China’s GDP expands in the mid-8% range, up from around 7.5% last year.
Meanwhile, the Nikkei Index in Japan gained 23% in 2012, its first yearly rise in three years. A steadily weakening yen is strengthening Japan’s export industry. The aggressive initiatives of the new prime minister, Shinzo Abe, may produce an end to decades-long deflation and finally jump-start a recovery in the world’s third-largest economy.
While I still am recommending that investors favor consumer-discretionary stocks (such as automobile makers), leisure/hospitality and housing-related stocks, I have become especially enthusiastic about stocks in the Asia-Pacific region for more aggressive investors.
