A smorgasbord of risks stateside

This political risk weighs heavily on small businesses, which cannot afford the legal advice and work needed to cope with the new regulations. The 50-employee threshold on health-care insurance has persuaded many small-business owners to stop hiring or to lay people off.

Furthermore, multinational businesses have abandoned their hopes that the 35% tax on profits earned and taxed offshore and brought back into the U.S. will be eliminated. As a result, the billions in cash will stay and eventually will be invested offshore.

All this implies that U.S. businesses will not be aggressive in their capital spending at home.

In addition to the new political risks, your clients have these factors to consider:

– VALUATION. The U.S. market is priced highly. For instance, the S&P industrials subindex (a subset of the S&P 500 composite index, excluding financials, transportation and utilities) trades at three times book value and 17 times earnings.

– Market Cycles. Stock prices oscillate, with the four-year cycle predominating. The market reached a major low in 2009, so another is likely in 2013. In addition, the “presidential cycle” of stock prices means the market is likely to drop during this year.

– INTEREST RATES. The final scene of a three decade-long bond bull market is being played out and, before long, cheap money will end. The huge sovereign debt of the U.S., as well as of its states and municipalities, and their projected steep increases contain the seeds of high inflation and a devalued currency. Industry’s interest costs could rise suddenly.

– WORLD ECONOMY. Europe is in recession yet again; Britain is trying to avoid recession; and the “BRIC” countries (Brazil, Russia, India and China) are struggling, all of which is a challenge for the many U.S. multinationals and exporters. About half the companies in the S&P 500 composite index break out their worldwide sales, which account for 46% of their total sales.

– PENSION OBLIGATIONS. Underfunding of corporate pension plans increased to $355 billion in 2011 (the latest data available) from $245 billion in 2010. This will divert more cash from corporate income. (All figures are in U.S. dollars.)

On the plus side, dividend payments will increase, despite the slew of extra and advance dividend payments as of yearend 2012. Payments on the S&P 500 composite index set a record at $281 billion. Analysts with Standard & Poor’s Financial Services LLC expect 2013 will beat that.

Here’s a look at S&P analysts’ expectations, by sector:

– INFORMATION TECHNOLOGY (IT). A shift away from business spending on computers and servers will handicap this sector. However, there will be growth, albeit slowing growth, in tablet and smartphone manufacturing. As a result, the sector’s 2013 earnings are estimated to rise by 5.9% above 2012 figures vs an average of 15.1% over the previous 10 years. (See table, above).

Because of the IT sector’s size, it was the largest source of dividends (about $41 billion) on the S&P 500 composite index in 2012, although the yield, at 1.7%, is low. The big companies are rich with cash, although mainly offshore and, thus, unlikely to bring it home to pay higher dividends.

S&P’s analytic division, Capital IQ, has identified Advanced Energy Industries Inc., Arris Group Inc., ATMI Inc. and Microsemi Corp. as potential outperformers.

– FINANCIAL SERVICES. As Europe appears to be avoiding a credit crisis, the outlook for banking is more optimistic, with an expected 12.9% rise in earnings this year.

Bank balance sheets have been repaired, but new regulations add to costs and the complexity of doing business. This will lead to more consolidation, as legislation designed mainly to deal with the megabanks will harm many of the U.S.’s 7,000 small banks.

Big banks, such as Bank of America Corp., Citigroup Inc. and Wells Fargo & Co., stand out as strong stocks. Among the regionals, BB&T Corp. is recommended.

Property and casualty insurers escaped the harshest effects of the credit crisis and the wave of new regulations. Allstate Corp. appears to have the most upside potential.

@page_break@- HEALTH CARE. This is the most problematic sector because of the unknown effects of many aspects of Obamacare and the possibility of unexpected changes in health-care legislation during the continuing economic policy debate.

The bottom-up consensus estimate is a 5.1% rise in earnings in 2013, well below the 10-year growth rate.

Pharmaceuticals account for half of this sector, and the long-term outlook for them is bolstered by the aging world population and its need for drugs. In addition, the massive research efforts of the major drug makers are starting to produce positive results, making major producers such as Merck & Co. Inc., Pfizer Inc., Johnson & Johnson and Abbott Laboratories appealing.

Biotechnology shares are currently sluggish, but new products are under development. The U.S. Food and Drug Administration has more than a dozen products on which it will make approval decisions in the first quarter alone. Firms involved include large-caps such as Celgene Corp., Roche Holding Ltd. and Biogen Idec Inc., as well as small-caps such as NuPathe Inc., Sucampo Pharmaceuticals Inc., Hemispherx Biopharma Inc. and Zogenix Inc.

S&P analysts believe the new health insurance exchanges will benefit Amerigroup Corp., Molina Healthcare Inc. and WellCare Health Plans Inc,

– CONSUMER DISCRETIONARY. This sector contains 32 industries, but movies and entertainment, restaurants, and cable and satellite services account for one-third of the sector.

This sector is fast-growing, and earnings are forecast to rise by 13.5%. However, restaurant and discount retail sales stumbled in late 2012, illustrating the sectoral risk: consumer spending is sensitive to consumer optimism.

Advanced Auto Parts Inc. and Hasbro Inc. stand out as dividend-paying favourites.

– ENERGY. Increased natural gas and crude oil production from shale is transforming the U.S. from a needy importer of raw petroleum toward self-sufficiency again.

Yet, this is the only sector in which earnings are expected to drop in 2013. The problem is flat demand, higher costs and probable additional regulations.

It’s the big international integrated companies that pull the sector’s dividend yield to a market average and they continue to be the least risky and most stable in this sector because of their diversification and size.

Exxon Mobil Corp. and Chevron Corp. are favourites.

Coal may be an upside surprise. The Obama administration is trying to shut down coal-fired power plants, but rising natural gas prices are reducing this risk.

Alpha Natural Resources Inc. is a pick in this subsector.

– CONSUMER STAPLES. For defensive-minded investing, this is an attractive sector. It has the most stable earnings flow and highest dividend yield aside from the regulated utilities and telecommunications sectors and share prices tend to drop by less in bear markets. For instance, when Wall Street fell by 57% in the 2007-09 bear market, consumer staples dropped by only 35%.

S&P analysts view 2013 prospects positively, with a consensus 7.1% earnings rise projected. That’s slightly below this sector’s 10-year growth rate, which suggests performance in 2013 may be better than expected.

Big, steady-growth brand-name companies include Procter & Gamble Co., Philip Morris International Inc., Coca-Cola Co., Wal-Mart Stores Inc. and Pepsico Inc.

– INDUSTRIALS. The U.S. leads the world in big manufactured products, including jetliners, huge earth-moving equipment, railway and mining equipment, and industrial engines. Defence products are another specialty. An above-average dividend yield also enhances this sector’s appeal.

Estimated earnings growth of 4.7% in 2013 is a little surprising, given the recent downward trend in new orders for non-defence goods (excluding aircraft).

Leadership in this sector was mixed as 2013 began, with United Technologies Corp., 3M Co. and Boeing Co. starting uptrends. General Electric Co., the largest company in this sector, expects 2013 will be much like 2012. Bullish trends are prevalent among smaller companies, such as Cintas Corp., Eaton Corp., Illinois Tool Works Inc., Iron Mountain Inc. and Lockheed Martin Corp.

– UTILITIES. This may be the sleeper of 2013. If dividends are going to provide most of your clients’ total return in the next few years, both the utilities sector’s yield, at an average of 4.3%, and its valuation, at 1.7 times book value, are very attractive

The risk for Canadians is currency. Should the Canadian dollar (C$) ride above par vs the U.S. dollar (US$), the incoming US$ dividend cheques will buy fewer C$.

– TELECOMMUNICATIONS SERVICES. Billions of bits and bytes of data, talk and videos pass through telecom systems, yet sector earnings have struggled. That’s changing; the earnings estimate for 2013 is a 22.8% jump vs 2011.

Telecom companies are building fibre-optic networks to replace their copper-wire systems. AT&T Inc., for example, plans to invest $14 billion over three years to replace its landlines and to connect its wireless hubs.

– MATERIALS. In the U.S., the big subsectors are chemicals, fertilizers and industrial gases. But S&P analysts rate the smaller aluminum and forest products subsectors as the most favoured industries in this sector for 2013.

Among the major materials companies, only Monsanto Co., Newmont Mining Corp., EcoLab Inc. and PPG Industries Inc. are currently trending upward.

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