2012 Outlook: Stocks will beat bonds
For all the trouble and turmoil, it's been another banner year for bonds and a pretty pathetic one for stocks. Next year, however, should bring a reversal of fortune, at least by the reckoning of one big wealth management firm.
That means most long-term investors would do well to set their New Year's asset allocation in favor large-cap stocks over bonds.
"Our 2012 economic outlook is for a moderate recovery, which should provide a constructive backdrop for the markets," writes Bill Stone, chief investment strategist at PNC Financial Services, in the firm's just released year-ahead outlook.
"Based on this environment and current valuations, future expected long-term real returns from stocks remain attractive, in our opinion, when compared with other assets such as cash or Treasury bonds," Stone adds.
It may be difficult for investors to abandon the relative perceived safety of bonds, especially in light of what 2011 has delivered in terms of comparative performance.
The iShares Barclays 7-10 Year Treasury ETF (IEF), for example, has returned more than 14 percent for the year-to-date -- despite yielding a paltry 2.7 percent, according to data from Morningstar. Meanwhile, stocks, as represented by the S&P 500, are barely above breakeven so far in 2011.
True, Stone expects a continued trend of rolling crises to roil the markets from time to time next year, just as they have in 2011. The vulnerability of the markets to ongoing fiscal policy debates and the eurozone crisis are just a couple of examples that come to mind, Stone says.
But since it's PNC's belief that "markets occasionally overreact to current fundamentals or concerns, it is far better for investors to focus primarily on valuation and fundamental factors combined with their longer-term expectations, goals and risk tolerance when making asset allocation decisions."
That makes stocks more attractive than bonds or cash for most investors' risk appetites in 2012, Stone says. Here's a look at PNC's recommended baseline asset allocation models for five classes of risk tolerance:
Within stocks, PNC heavily favors high-quality, large-cap stocks, especially those that pay dividends. The firm also recommends overweighting value stocks vs. growth in that big part of the large-cap pie:
Additionally, PNC recommends equity investors stick close to home, with the great majority of their stock portfolios invested in U.S. rather than foreign companies:
Given the current historically small difference between the yield on the S&P 500 and the benchmark 10-year Treasury note, Stone figures it's just a matter of time before investors are essentially forced out of their bond holdings and back into quality stocks.
"With cash on the sidelines waiting for less uncertainty, the return of confidence would likely send investors back to stocks, which would buoy momentum," Stone writes. "We suspect investors will reach first for stocks that meet the criteria of relative safety and income production -- dividend focus."