Economics & Strategy
U.S. Equity Market Outlook: A Bumpy Ride, But a Happy Ending
—Sean Darby, Global Head of Equity Strategy
The Federal Reserve has opted for financial repression to liquidate public debt. Hence real interest rates will remain
low for an extended period. We expect U.S. equities to outperform U.S. government bonds in 2013. Global growth is
set for a period of extended weakness as the developed world undertakes a period of austerity. Deflationary forces are
being offset by massive central bank balance sheet expansion. Much like the U.S. yield curve, which has flattened, U.S.
corporate profits are peaking as the economic recovery matures. We expect the U.S. economy to grow modestly in
2013 and the S&P 500 to rise by a modest double-digit gain of 11%, implying an index target around 1,565. Margins
are likely to remain higher for longer.
While fiscal and external shocks remain, U.S. equities have become more closely aligned with corporate credit markets
in the short term. Housing will continue to flourish, but the surprise may come from changes in the U.S. corporate tax
code to encourage companies to invest. We continue to highlight the relative competitiveness of the U.S. to other
leading economies and highlight the positive shock from falling energy costs. We also recommend companies with
high ROE, stable margins and strong balance sheets as we expect the quality investment theme to continue in 2013.
Although growth disappointments may overshadow the market, it is changes in corporate bond spread that will be
the main risk in 2013.
We expect a bumpy ride, but a happy ending. We expect that politicians will stumble through a series of crisis-driven
events (debt ceiling, threat of government shutdowns, etc.) on the way to a long-term budget plan that falls short of
being ideal, with the resulting budget deficits still large by pre-2008 standards. But the lower deficit and debt/GDP
projections will be enough to satisfy the credit rating agencies. We believe the economy will suffer through the first
half of 2013, but begin to regain momentum in the second half of the year, with the same positive factors having a
delayed and somewhat reduced effect on growth.