What to Watch for in 2013

 | Dec 04, 2012 | 9:15 AM EST  | Comments
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We are coming up fast on the end of 2012, so it's time to think long and hard about what the coming year will bring for investors. Here at Real Money, contributors are brimming with market predictions, economic musings and stock picks for 2013 -- and you'll find a number of choice ones here. Below are individual stock recommendations for the coming year, general market predictions, currency insights, thoughts on the bond market and more.

Feel free to browse through and offer your own thoughts in the comments section.


 

Jim Cramer: Stock Pick

When Wells Fargo (WFC) last reported earnings, people focused on how the bank failed to blow out the net interest margin, and that it didn't make enough money playing the yield curve.

What they didn't focus on was Wells Fargo's attempt to take over the world.

So many companies mouth the axiom that a crisis is a terrible thing to waste. But most do nothing in the crisis except hunker down. Most executives are scared to do more than that, while others fear doing so may be too expensive. I mean, who knows when the crisis is over?

Then there is Wells Fargo. From the day the mortgage crisis began, Wells decided to go on the offensive. The company had a sixth sense that it would be allowed to do what no other bank had ever been able to do -- to go beyond the 10% market share that a bank is allowed to have in the U.S. The executives running Wells figured, correctly, that this country would be so desperate that it would look the other way when it came to deals that normally would have been stopped in their tracks by the Justice Department.

Now, the bank was able to acquire Wachovia and expand while others retrenched, and in part because the bank talked a big game about using a crisis but ultimately backed down. Because of this, Wells owns about one-third of the whole nation's mortgage market.

Of course, expanding rapidly across the entire country costs a great deal. That's one of the reasons Wells Fargo had a disappointing last quarter. But you have to understand its strategy. It likes touch. It gets your mortgage, and it cross-sells other products. That's how it's been able to maintain double-digit growth throughout this period.

Beginning in 2013, two things are set to happen. First, the national bank build-out will be finished, with related expenses taken. Second, housing will come back, so many of the mortgages that were underwater will now be above water. Wells has already modified almost a million mortgages. A rising housing market makes these modifications that much easier to do.

Now, here's the kicker. The Street believes Wells Fargo can earn about $3.30 per share next year. With housing coming back, and with much lower expenses, I wouldn't be surprised to see the bank earn $4.30 per share. This bank has always held a premium to the group, and has often traded at a market multiple -- but forget that latter item. Let just give it the current multiple: 10x. You could see this bank rally to $43 on that, a standout gain for a standout institution. That is why Wells Fargo is my No. 1 pick for 2013.


 

Doug Kass: Stock Pick

In a global economic backdrop characterized by subpar growth, market participants are likely to embrace those companies that can grow at above-average rates. Ocwen Financial (OCN) personifies what investors should be looking for in the year ahead -- earnings growth that's well above average, and a stock priced at a reasonable price-to-earnings multiple.

Lately, the world's major financial institutions have been downsizing their business platforms, owing to the legislated and mandated need to reduce leverage ratios -- and Ocwen is a beneficiary of this trend. One business line that banks are universally dropping is that of capital-intensive mortgage services, and Ocwen has emerged as the largest buyers of these properties. It has bought them from Goldman Sachs (GS), Barclays (BCS), Morgan Stanley (MS) and even the U.S. government (via ResCap). Ocwen's scale, unmatched by other industry participants, means it can profitably acquire these jettisoned bank assets.

Earnings for Ocwen, at less than $1.50 per share in 2012, should grow to nearly $5 per share in 2013. This is thanks to an aggressive -- and almost immediately accretive -- acquisition strategy, as well as a headquarters move to the Virgin Islands. That latter item should reduce the company's effective tax rate to around 10% next year.

The most exciting thing about this investment, however, is that Ocwen has a robust pipeline of nearly $350 billion in potential acquisitions.

At a price-to-earnings multiple of only 7x, Ocwen should continue to be a very rewarding investment.


 

Stephanie Link: Stock Pick

The industrial space has been been one of the worst-performing groups in 2012, largely due to the global macroeconomic slowdown and uncertainties around the U.S. fiscal cliff. But diversified industrial firm Eaton (ETN) is one name that has bucked the trend, with shares having climbed more than 18% year to date. Over the last decade Eaton has transformed itself from a cyclical truck-and-industrial equipment maker into a power-management company with an emphasis on energy-management solutions -- an area that has seen strong secular growth as companies have tried to deal with rising energy costs and the need for more efficient equipment. It holds either the No. 1 or No. 2 position in each market that it serves, thanks to its 50-plus acquisitions and 10 joint ventures since 2000.

While the stock has been one of the stronger performers in the group year to date, I think 2013 will set up in an even better fashion, given the soon-to-be-closed Cooper Industries (CBE) acquisition and the synergies that this will bring. Cooper makes a variety of electrical equipment, and the buyout is a direct play on nonresidential construction -- an area I like within the industrial segment. Its end markets include industrials (with customers here as blue-chip as they come), along with utilities and a commercial segment.  

The $11.8 billion deal -- the largest on record for Eaton -- will really transform the company. For one thing, the combined entity will have a good mix of early-, mid- and late-cycle businesses, which stands to smooth out Eaton's earnings base. That should raise the stock's multiple from the current 11x forward earnings, and bring it closer to the 13x average for the electrical/conglomerate group. The Cooper acquisition also gives Eaton more North American exposure and, most important, it marries two industry leaders with complementary electrical businesses. At the same time, it is consistent with Eaton's strategy to expand in this higher-margin, faster-growing segment.

Cooper brings $5.4 billion in sales and carries 14% operating margins, and the combined company will enjoy broad-based end-market exposure in the right areas, with the ratio of electrical-and-aerospace sales to rise substantially as we see a decline in the percentage of auto, truck and hydraulics revenue. In 2013 I expect electrical will benefit from continued improvement in construction and from a reacceleration in power-quality markets. Aerospace should find support in aircraft-replacement and maintenance demand -- and autos, with a 2-percentage-point decrease in total revenue share, should benefit from new products and technology to improve vehicle fuel economy.  

Synergies are expected to be earnings-accretive by $0.35 per share in 2014, with dime-a-share climbs anticipated in both 2015 and 2016 -- and management is likely to exceed those targets, given its strong M&A track record. Eaton recently reiterated its 2011-to-2015 financial goals, which include 12%-to-14% sales growth, 20% compound earnings growth, healthy margins and free cash flow, and nearly one-third of revenue to be derived from emerging markets. With CEO Sandy Cutler running the new company, I expect continued strong execution in achieving these goals.


 

Roger Arnold: Bond Forecast

U.S. bank loan growth has been anemic of late, having come in at about 1.25% annually since the recession ended in June of 2009, even as the Federal Reserve has engineered the lowest cost of debt capital in history. Lenders are not lending, and borrowers are not borrowing. I expect the Fed to respond to this lender/borrower malaise with another round of QE that will focus on rapidly lowering long-term U.S. Treasury yields and loan rates by an average of 50 to 100 basis points. That implies a 10-year Treasury yield of 1%, a 30-year bond of 2% and a 30-year mortgage of 2.5%.


 

Helene Meisler: Stock-Market Forecast

If we forget the fiscal cliff and just look at a weekly chart of Nasdaq, we see that this current rally looks as though it should form the right shoulder of a head-and-shoulders top.

Nasdaq

It ought to take a few more weeks for the Nasdaq to rise toward the underside of that black uptrend line -- which, at present, comes in around 3100. That is essentially the same level where the left shoulder has formed. That would make the chart very symmetrical -- too perfect, perhaps -- but this is the general picture I see. If the indicators fail at lower highs, as I expect they will do, that could coordinate with the right-shoulder formation when the oversold rally is done.


 

Tom Graff: Bond Forecast

I predict that the Federal Reserve will continue quantitative-easing purchases through all of 2013. The purchases will shift from just mortgage-backed securities to include U.S. Treasuries sometime in the first quarter, but the fall will also include some even more non-traditional assets and/or direct lending programs.

By mid-year, the Fed will give us specific targets for both unemployment and inflation, which will probably be 5.5% and 2%, respectively. Jobs growth will accelerate mildly from a recent average of 170,000 to the low 200,000 area -- but, given the Fed's announced employment targets, it will be clear that 5.5% unemployment is a long way off, even given mildly faster job growth.

This will keep Treasury rates in a very tight band -- between 1.40% and 1.90% -- for most of the year. Bond-buyers will continue to be squeezed by low short-term rates, and will choose high-grade corporate bonds as their favorite alternative. Investment-grade credit spreads head toward all-time lows.


 

Christopher Versace: Stock Pick

Looking forward to 2013, one company I'm looking at is Starbucks (SBUX), for which a number of growth initiatives should hit next year. This company continues to expand internationally, for one thing, and it has also recalibrated its growing food business to include such recent acquisitions as La Boulange Bakery and Evolution Juice, as well as a deal to buy Teavana (TEA).

Margins should also benefit from the continued fall in coffee prices, which are down 24% year over year, per the International Coffee Organization. As if all that weren't enough, Starbucks' board has increased the quarterly dividend by 24% to $0.21 per share, and upped the share-repurchase program to as much as 25 million shares, or 3.4% of the total outstanding-share count. Those two initiatives provide a solid floor in the stock, while the top-line growth and prospects for margin improvement should drive climbs in earnings per share. As we all know, that tends to translate into multiple expansion -- a pretty good treat for the new year.


 

Eric Jackson: Stock Pick

Yahoo's (YHOO) recent stock move is just starting, and I believe these shares will reach $30 in 2013. Why?

● The company has only completed 24% of its planned $3 billion stock-buyback.

● If Alibaba doesn't publicly debut in 2013, it will become evident that the entity is worth at least $60 billion, meaning Yahoo's remaining 24% stake will be worth nearly $9 billion after taxes.

● Yahoo can tap the cheap debt markets to further fund stock-buybacks.

● It can still cut a lot of headcount at the company to further boost earnings before interest, taxes, depreciation and amortization.

● The market is likely to boost Yahoo's ratio of enterprise value to EBITDA (EV/EBITDA) to at least that of AOL (AOL).


 

Ed Ponsi: Macroeconomic Forecast

I expect Europe to continue slowly fracturing, with wealthier nations such as Germany becoming increasingly unwilling to finance bailouts. This will cause the slide in the euro to resume, pushing capital out of Europe and toward the U.S. -- which, in turn, will cause the dollar to rally.

In Japan, Shinzo Abe is likely to become the next prime minister. Abe plans to enact reforms designed to dramatically weaken the yen, which would similarly push capital away from Japan and toward the U.S.

The U.S. economy is on track to continue growing slowly as Europe and Japan slide into recession.

All of these factors favor a strong dollar in 2013. I anticipate that, next year, the dollar index will strengthen to 84 from its current level of 80.5. The 84 level also marks the high point for 2012, which was achieved in July.


 

Jared Woodard: Currency-Based Pick

Japanese stocks are some of the most unloved assets in the world. But there are several reasons why equity from this country, tempered by short upside option skew, is one of the best opportunities for 2013.

First, we should be clear about the case for skepticism. The slow global growth picture is bad for an export-dependent country like Japan, and most economists don't expect a major improvement in world gross domestic product in the coming year. Making things worse this year has been weakness in China, Japan's largest export market, which has territorial disputes with Japan and may implement a boycott. Further, Japan's balance of trade (exports minus imports) turned negative in 2011.

Another complicating factor has been the strong yen, which has made Japanese companies less profitable and globally competitive. This is a nation of aggressive savers with a notoriously high ratio of public debt to GDP, leaving foreign interest quashed: Global fund managers now have the least Japan exposure for 10 years, according to a Merrill Lynch survey.

Japanese stocks kept pace with U.S. large-caps before the financial crisis, but since mid-2009 they've lagged returns in the SPDR S&P 500 (SPY) by almost 40%.

But, despite this poor track record, each of the problems cited above is reversing course. For instance, one cause of the current-account deficit has been a set of temporarily higher import costs -- so this metric should improve. So should exports, for that matter, given the containment (and likely future improvement) of China territory issues, as well as the fact that China seems to be avoiding the oft-mentioned "hard landing" scenario, per economic data. China's gradual shift from exports to domestic consumption will also be a favorable long-term tailwind for Japan. The U.S. is its second-largest export market, and if American consumers start feeling wealthier amid firming real estate and eased fiscal worries ease, Japanese companies will see higher profits here.

As for the yen, the currency should weaken in 2013 -- a view that has become one of the most-talked-about scenarios on Wall Street, including among analysts at Goldman Sachs, Morgan Stanley. Shinzo Abe, likely to be elected the next Japanese prime minister, has suggested he will aggressively push the Bank of Japan to work directly with the government on debt management, including the buying of bonds to finance infrastructure projects. As Alan Ruskin at Deutsche Bank has reminded us, in 1999 Ben Bernanke argued (PDF) that a depreciation of the yen would "by itself probably suffice to get the Japanese economy moving again." 

Markets are already starting to price in the possibility of reflation. The relationship between the two-year interest rate differential and the dollar-yen cross is approaching historical extremes.

Dollar-Yen Cross Deviations From Two-Year Rate Differentials
Source: Deutsche Bank

The implied volatility skew in options on the same pair is steeper than it's been at any time since at least 2005.

Dollar-Yen Cross -- 10% Moneyness Three-Month Implied Volatility Skew.
Source: iVolatility

Expectations have also filtered out to Japanese equities, as far-out-of-the-money call options are priced at richer levels of implied volatility than at any time since 2007.

Nikkei 225 -- 14-Month 120% Upside Implied Volatility Skew
Source: BNP Paribas

There are some objections to the plausibility and/or desirability of the short yen thesis, but none are particularly strong. First, there's the argument that the Bank of Japan opposes the idea of weakening the yen; but Abe can make new appointments in the BOJ. Second, it's said that Abe will lose credibility with his too-aggressive 3% inflation target; but, due to the coalition his party will likely need to form, that aggression is liable to be tempered. A third argument says Japan will see fierce global political opposition to devaluation; but, as Ruskin argues, Japan should at least be able to dampen complaints if it recycles its reserves into dollars, euros and other currencies with enough equanimity.

Finally, it's been argued that the government will set off a hyper-inflationary collapse. But we've seen warnings about the unsustainability of low Japan interest rates for years now, some from fund managers have also been wrong about the presence of a U.S. "bond bubble." Credit default swaps on Japanese debt reflect a low-risk premium, the central bank is willing to act as a lender of last resort, and policymakers know that they must ensure any fiscal efforts go to productive assets.

There is another accelerant for any sizable yen move: Morgan Stanley analysts have noted the large flows into yen-denominated money-market accounts in the last two years, with investors hoping currency appreciation will justify the trade. A sufficient decline in the currency will cause a flight from those money market accounts and drive the yen lower still.

In light of all this, we are net buyers of iShares MSCI Japan Index (EWJ) options expiring in June 2013. EWJ is a liquid ETF whose average daily option volume of 12,000 contracts is sufficiently high to allow U.S. investors to take advantage of the volatility. 

Buy the EWJ June 2013 $9 calls for $0.56 and sell the June $10 calls for $0.17.

The reason we are selling rich upside call skew is to reduce the cost of the position in case of a disappointment in central-bank efforts, an adverse move in the currency or weakening demand for exports. The $10 strike calls are priced at 106% of the trailing 200-day realized volatility, so again, the relatively rich skew means we are willing to sell the upside potential in exchange for a lower outlay. The maximum profit on the trade, with EWJ at or above $10 at expiration, represents a 56% return on the price of the spread. We may look to add to the position or roll it out in time after an updated outlook in March or April.


 

Timothy Collins: Commodity Pick

To start with, the early part of 2013 probably won't be a big friend to energy -- although I do expect natural gas to get a big bump here if it holds at support levels into the end of the year, as seen in the United States Natural Gas Fund (UNG) chart below. There is still good potential here, but it looks short-lived, as I expect to see some softening once we get past the meat of the winter. In other words, if you missed the upside, don't expect much come February. After that point, I'd wait for mid-May, then take some shots long in natural gas.

UNG -- Daily
Source: StockCharts.com

However, the real energy-sector opportunity in 2013 -- albeit a speculative one with a very high risk-reward level -- may come from coal. This isn't an attempt to make a generational low call or to swing for the fences; it is based on the idea of compromise and realization. The fiscal cliff, and the compromise it will entail (which I believe will occur early next year), stands to put some pressures on politicians to sniff reality. This compromise may also get the economy going again, not only in the U.S., but worldwide.

Any increase in confidence and economic action, meanwhile, is likely to be seen in oil. As we know, an uptick in oil prices is immediately felt in gas prices and the consumers' pockets. High gas costs do not make voters happy -- and, at some point, President Obama will have to compromise on at least one of his major viewpoints. We all know it won't be healthcare, so the easy answer is coal. It is no secret that coal has been in Obama's crosshairs, as clearly reflected in U.S. coal-related shares.

Alternative energy is nice and will still have a place, but "nice" doesn't win votes, and it doesn't ease energy prices. Some support for coal will ease energy prices, and this is an easy compromise for the government to make. So I suspect that, sometime shortly after the end of the first quarter, it will be time to get long coal and coal-related names. Optimism will enter the sector before compromise and reality will. If you wait for compromise and reality, then you'll miss the big money.

There is still downside potential in coal, so this isn't a riskless trade, even as coal names continue to fall through the first quarter. However, the logic for a trade exists. I believe several names are in the process of forming a bottom, though the process does take time -- the span of the first quarter, I believe. After that, I will be getting long pure plays in the coal sector with very loose stops, most likely some 20% off the recent lows or the lows seen in the current fourth quarter. The use of slightly in-the-money or out-of-the-money options seems like a practical approach, if I can use the word "practical" in relation to coal. Watch this sector closely, as I think it will be the late bloomer and big surprise in 2013.

 


Skip Raschke: 4 Areas for Listed Options

Way overdue! That's my 2013 mantra. We are overdue for a big year in four stock market related areas: mergers, acquisitions, P/E expansion and rising interest rates.

We are overdue for mergers because synergy is a very powerful method for boosting stockholder value as well as corporate growth.

We are overdue for acquisitions, friendly or hostile, because historically many stocks are quite undervalued relative to their future earnings power. In addition many companies have historically high levels of free cash.

We are overdue for an elongated period of P/E expansion as the various impediments to corporate earnings growth are overcome.

The last on my overdue list is the huge elephant in the room on Wall Street: the end of the 30-year bull market in bonds as interest rates finally begin to rise. That momentous event will only occur if economic expansion gets reinvigorated.

The best way I know how to take advantage of these four overdue potentials for 2013 is by using listed options. Options can be employed by both the investor as well as speculator. In most cases 100% of the underlying risk can be controlled while having leverage working in their favor should they be positioned correctly for the move.

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