Roundtable: Top strategists' moneymaking tips for 2012

— -- The outlook for U.S. stocks next year is not wildly bullish. Nor is it depressingly dreary. The buzzword is "cautiously optimistic," say six top investment strategists and fund managers who took part in USA TODAY's 16th annual Investment Roundtable. The main source of trepidation is Europe. How its debt crisis plays out will largely dictate whether markets thrive or dive. U.S. politics could also move markets as the election nears. The good news? Barring a "shock," a recession is unlikely. What's ahead in 2012?

Q: Is it possible to make money in a world dominated by debt, deficits and doom and gloom?

Kate Warne: Yes. I will give you two reasons why. The first is, if you put money in at the stock market peak in October of 2007, and you owned 65% stocks and 35% fixed income, you actually would have been up 10% at the end of November. All you needed to do is rebalance your portfolio once a year. People have been really nervous. But if you stayed invested in a normal (balanced) portfolio of stocks and bonds, you did fine.

Second, the pessimism today is actually creating opportunities for investors. There are a lot of short-term concerns, a lot of serious risks, but investors really need to keep their eyes on the horizon, because we are also seeing strong fundamentals (such as strong profit growth from Corporate America and better economic data, including better news on the jobs front). And that is what is driving the market longer term. I am cautiously optimistic.

Q: Bob, are you optimistic about 2012?

Bob Doll: Cautiously optimistic. Europe is the main show on the stage. Everything else is a sideshow. And that is probably the case until we get a little more clarity there.

Can you make money? The probabilities go up depending on your entry point. And the entry point now is low expectations and pretty reasonable valuations. (Editor's note: The Standard & Poor's 500 index is trading at roughly 12 times next year's estimated earnings, says S&P Capital IQ, which is below the average P-E, or price-to-earnings ratio, of 15.) Look at October and how strong that was (the S&P 500 rose nearly 11%). We did not get good news; we got less bad news. I think if we get some more of less bad news, it will allow us to make some money in stocks.

Q: Ann, do all the fears make your job more difficult as a stock picker?

Ann Miletti: The volatility makes it difficult, but the fact that expectations are low is the best thing we have going for us. People are afraid, and there is a lack of confidence. But that is when you actually want to put money to work. When there is comfort and euphoria, that is probably when you want to start selling. There is a lot of uncertainty in Europe, as well as domestically with our deficit and upcoming election year. But once we have all of the answers, it will already be priced into the market.

Q: Rich, what's your outlook for next year?

Richard Bernstein: Investors have always been able to make money. People still talk about the lost decade in equities. That is absolutely wrong. The question is: Where did you invest?

If you go back 10 years ago, people were all excited about the U.S. and technology. People thought this was the place you had to invest, and the next 10 years turned out to be completely different. Emerging markets and commodities outperformed.

And most investors today are still talking up emerging markets. So now we have people again believing that what has worked is where they should be putting their money. People are setting themselves up for another lost decade. The reason I say that is people don't understand that the S&P 500 has now outperformed the BRIC nations (Brazil, Russia, India and China) for four years.

We are in the very early stages of a resurgence of the U.S. equity markets, and I don't think people are aware of the shift that is going on.

Q: Tom, your optimistic outlook for 2011 didn't come to fruition. Is your bullish investment thesis still intact?

Tom Lee: As I look back at the 2009-10 bull market, it made a lot of sense to be contrarian and bet against the pessimism. But this year, because the European crisis really intensified, it made sense to kind of go with the crowd. But 2012 is really setting up to be a year to be a very big contrarian and (bet against the negativity again).

Q: Why do you think stocks will rise despite the ongoing angst?

Lee: We are seeing the endgame develop in Europe. (We are) betting on Europe finding a road map. (Our bullish market call) is a little bit like buying a semiconductor stock two quarters ahead of the inventory turn. I think next year people might be talking about Europe exiting recession rather than talking about entering it this year.

The U.S. market will also be driven by corporations buying back their own stock. Corporations have been the real buyer of stocks over the past decade. Buyback activity was up sharply this year. (S&P estimates buybacks for its benchmark stock index will hit $439 billion in 2011.) And buybacks might be up sharply again next year. (S&P estimates $500 billion next year.) That would represent a historic inflow into equities in 2012.

Political outcomes also favor equities. It is generally a good time to buy stocks when presidential ratings are low, as Obama's are now. There have been eight election years when the president's approval rating was below 50 at the start — and all but one saw gains. Low approval means markets see a change in office, which is good for stocks. If the economy recovers and the incumbent wins, that's also good for stocks.

Q: Dan, is there opportunity to make money in growth stocks?

Dan Chung: Investors seem very frustrated this year. The headlines, of course, have been grabbing a lot of attention: Budget talks in the U.S. that have gone nowhere. A supercommittee that was anything but super. The European crisis. A nuclear accident in Japan, and rising protectionism across the globe. And yet the U.S. markets are essentially flat and among the best markets in the world.

Q: The market held up mainly because corporations grew earnings more than 15%, right?

Chung: Companies in the S&P 500 have proven that they can earn about $100 a share, which (means the market sells at) 12½ times earnings and has a dividend yield of 2.5%. It is an excellent period for investors with patience to be strategically looking at the opportunity in U.S. stocks.

Q: What's your bear — and bull — scenarios?

Chung: Here's my way of looking at the bear case. The great fear is that we see a significant U.S. recession where earnings decline, say, 20%. The S&P 500 companies are earning $100 a year now, so profits will fall to $80.

Then the question is: What should the market be priced at $80 in earnings? You can take a 12 multiple and you get down to 960, (which is 21% below Thursday's close of 1216). But when you get that depressed you really should have a higher P-E multiple. (That's) because the market looks forward and has seen the profit recovery and resiliency of American companies in the last two scary recessions — one following the tech stock bubble bursting 10 years ago and the financial crisis a few years back. So the P-E multiple shouldn't be 12 on $80 of earnings if we had a serious recession; it should be 15. And that gets you back to 1200 (basically where the market is trading at now). There is not that much downside. That's not to say that in a sentiment-driven market, we don't get to 960 briefly if markets (react badly to events in Europe).

Q: What's your bullish thesis?

Chung: It doesn't take much to get significant upside if we get past the euro crisis, and Europe's resiliency surprises us a little bit and they make some progress through some of the reforms that they need to make. More important, (it will also help) if the emerging markets, where regulators and policymakers have been tightening policy in attempt to constrict the bubble, start to ease (i.e., lower interest rates and borrowing costs). There is, of course, risk of a contraction. But the markets will respond going forward to growth-supportive policies. And I think there can be a surprising restoration of investor confidence, just like we saw in 2009 and 2010.

Bernstein: To just add one thing on investor confidence. People have to realize that the major bull markets in history have never begun with investor confidence. If you go back to 1982 (the start of the biggest bull market ever), people were not saying, "Oh, we have to be in stocks." People were saying, "We have to be in money market funds" because the interest rates were so high.

Europe expected to be ongoing issue

For months, U.S. stocks have been driven up and down by headlines out of Europe. One day stocks soar on hopes that eurozone policymakers have finally hatched a viable plan to solve its debt crisis — only to plunge the next day on gloomy news about the ongoing risk of financial contagion or the European Central Bank's refusal to act as the lender of last resort for European countries in need of capital.

Q: Will U.S. markets be held hostage by Europe again in 2012?

Chung: If you look at U.S. corporate fundamentals and the direct exposure to Europe and the knock-down effect from the emerging-markets exposure, this is going to put a crimp in the profit growth potential for many companies next year. But a good amount of that is already priced into many stocks.

Q: How do you see the Europe crisis playing out?

Chung: I see two scenarios. Scenario A is a market riot (or big sell-off in stocks, bonds and other assets) that forces European politicians to act. Scenario B is European policymakers and banking regulators getting ahead of the markets and doing something good and, therefore, markets don't riot. Oddly enough, both of those scenarios pretty much end up in a better year for European stocks and U.S. and global equities.

Q: Would a really bad outcome in Europe — say a really bad recession or serious credit crisis — cause a market decline like we saw in 2008?

Warne: If we get a worst-case scenario in Europe and the markets riot, we don't see as bad a reaction as we saw in 2008. You can use the analogy of the sequel never being as good as the original movie.

Companies, individuals and banks in the U.S. are all in a much better position than they were three years ago. Everybody is sitting on a lot more cash. As a result, (any financial market turbulence) happens faster and is less dramatic because everybody is hunkered down."

Doll: That is part of why the market is selling at just 12 times earnings. Back to Dan's point: If that happens, the authorities' backs will be to the wall and then they will do something.

Q: What if Europe just muddles through its problems?

Warne: We could end up with more of the same, because the European leaders never do as much as they need to do, but they always do enough to calm things down short term. And everybody thinks this will go away, and it doesn't.

Lee: I think what will happen is the core countries of Europe, such as Italy and Spain, come under attack. And the next stage is you will have a bank run, and that is going to force the hand of the European Central Bank (to respond more aggressively).

Doll: Perspective is important. We are in a post-credit-bubble-bust world. That means all kinds of folks and institutions have to delever by reducing debt. The consequence of that is below-normal economic growth, which means there are going to be accidents from time to time. Every once in a while somebody will not be able to make their payment and you will have a little crisis.

Q: What will those little crises mean for investors?

Doll: To put it in black and white: If it is just Europe has a recession, and we continue to muddle through on the credit stuff, the U.S. can be fine. We don't do that much business with Europe. The risk is if there is an accident — because the authorities in Europe stay behind the problem — and eventually a bank has to declare bankruptcy, and the system just comes to a stop.

Q: So basically a big bank failure would be bearish?

Doll: Yes. And so I think there are two risks. One we can deal with; the other is a little more serious. There is a 10% to 20% chance that a bank fails, or the financial system just doesn't operate well enough and the credit market just comes unglued one more time.

Q: Are investors too complacent in thinking Europe will muddle through and avoid a bad outcome?

Miletti: Individual investors are a little bit more disconnected from it relative to all of us professionals in the room. That is what is causing them to stay away from stocks. They don't understand it.

Q: Do you think that being too fearful is the wrong strategy?

Miletti: I do. There are certain segments of the market that are getting (affected) by Europe, such as financial and industrial companies. Those are the two sectors that we are analyzing for our portfolios. What will be the impact of a slowdown in Europe on the rest of the world economy? So, I don't think there is complacency.

Bernstein: Europe is a symptom of a bigger issue: the deflation of the global credit bubble. People have believed for way too long that the credit bubble was a U.S. event.

We are now finding out that Europe was part of that global credit bubble. The next shoe to fall will be the emerging markets. They were the biggest beneficiaries of the global credit bubble, and people don't realize that. That is going to be the big story in 2012 and 2013.

But you can still make money. The U.S. will be the shining star, maybe the best house on a bad block. But Europe is just one in a series (of credit crises) that we are going to see, and people should be prepared for that.

Are we heading for a recession?

Q: Fears of another severe slowdown have risen amid fears that Europe's debt crisis will cause a recession there and drag down the rest of the world. Will the markets next year be driven by recession worries?

Warne: We see more slow sluggish growth in 2012. We do not think that a recession is in the cards, unless you get a tax increase or an oil shock or something else. You need a shock to put the economy into a recession. The U.S. has less austerity than anybody. In Europe you have all these austerity programs. The U.S. said, "Not for us." I think that creates in 2012 a pretty good year.

Q: What kind of growth rate can we expect?

Warne: Over the last couple of months, basically all of the economic indicators have come in above expectations. You don't see runs like that forever. At some point in 2012, we will get another worry about a recession coming. But 2012 basically is another year of 2% to 3% growth overall, but bumpy along the way because the economies around the world are growing slowly with headwinds of all sorts, ranging from de-leveraging consumers and everybody being cautious about all of the worries from Europe.

Doll: Growth this year for the four quarters was 0%, 1%, 2%, 3%. And I don't think we extrapolate 4%, 5%, 6%, 7%. Wouldn't that be nice?

Economies do not grow in straight lines; recoveries are very uneven. If we average 2% growth again next year, you will have a 3% quarter somewhere in there and there will probably be a 1% quarter, which means we may have a recession scare again next year. When and how it happens, I don't know. We are still in this deleveraging world, where there are some constraints to growth, and 2% growth is not a bad number.

Q: Is there going to be enough economic growth to allow companies to grow profits?

Chung: We kind of like the setup for corporate profits, margins and earnings next year. The efficiency of supply chains through technology and globalization … allows companies to be leaner.

Q: Anything else make you bullish?

Chung: There are three major positives related to U.S.-oriented industries. Housing is still flat on its back in the U.S., but it is beginning to clear in some of the proprietary surveys that we do. We are not looking for a rocketing housing market, but even a marginal recovery is much less of a headwind and a big boost to economic growth.

Q: What are the other two potential drivers?

Chung: The auto industry. The fleet of cars is aging at a significant rate since the financial crisis, and that, too, will start to turn. There are some interesting things going on in the auto industry: the 35-miles-per-gallon mandate and alternative hybrid vehicles — and companies are adjusting. That will be a big boost if the auto industry starts to come back. Finally, there is some of the dislocation caused by really weird weather, and the Japanese tsunami.

How will politics affect the economy?

Q: Political gridlock in Washington hurt investor confidence and held markets back this year. A partisan fight over raising the debt ceiling this summer and lawmakers' inability to agree on a plan to reduce the nation's $1.5 trillion deficit cost America its gold-plated triple-A credit rating. What impact will the 2012 election, politics and policy have on financial markets next year?

Lee: (Throughout) history, Washington has always been a headwind to markets. It has never really been a tailwind.

Doll: Shut it down.

Chung: Let's occupy Washington.

Lee: There is a real frustration among businesses because Washington's regulations and tax policies have made it difficult for them to make capital decisions. So I do think that in 2012 there is potential for a pretty big voter revolution. For big business the optimum outcome is probably a Republican Senate, House of Representatives and a change in president. But I think that it's going to be very tough for all of that to take place. But markets are discounting mechanisms, and I think things couldn't be worse in Washington than they are today. There is a real sense of paralysis and frustration.

Q: What if Washington strikes out again and causes market confidence to deteriorate further?

Chung: That's Scenario C, the super bear, which is if the Europe crisis plays out (positively) and markets rally. But it gets cut off because of Washington, and an extreme rise in protectionism across the globe. It would be like a reversal of globalization, one of the biggest forward trends of the past 20 years.

Doll: One of the surprises in 2011 is that we have not had more of that sort of thing. Growth is slow. The politicians want to be re-elected. You know, protecting the jobs of the workers in my region — all of this protectionist sort of outcry.

Warne: I think we will see no steps forward but probably no steps backwards. Globalization is actually hard to reverse. We will see more cries for protectionism. But I think it takes awhile before those actually become actions.

Q: Will the U.S. political scene be a headwind or a tailwind next year?

Doll: Less of a headwind than it was. Why? There will be a lot of debate. Not much will get done.

Q: But some argue gridlock's not good for markets when things must get done?

Doll: I agree with that. I think (gridlock) is priced in. The market is expecting nothing next year. The expectation is things will get done in 2013 after the election.

Warne: Right now you have payroll tax cuts that expire at the end of this year. Everybody thinks those will be extended because nobody can think of any politician that wants to raise taxes on individuals in the beginning of an election year. But the Bush tax cuts expire at the end of 2012. So the impact is much more of a headwind in 2013.

I think we see more gridlock. But it doesn't actually change anything, because they have all put the deadlines off until after the election. But it is not a tailwind if nothing is done. The economy can keep going as long as we don't see the payroll taxes increase at the beginning of the year.

Bernstein: Whenever they decide to deal with the deficit, that will be a headwind. There is no way that either raising taxes or cutting spending is stimulative.

Q: So maybe gridlock is good after all?

Bernstein: One political reporter actually argues that politics next year will be a strong tailwind. His reasoning: Everybody will want to get re-elected, and we will see taxes go down and spending go up next year. One of the worst ways to get yourself re-elected is to tell people that they can't have stuff.

Q: So that would be the bullish Washington scenario?

Bernstein: Yes, because what it says is, you are going to get more stimulus, regardless of whether you are on the right or the left.

Q: But that strategy, while politically beneficial, might add to our deficit woes.

Miletti: Europe should be a looking glass for the U.S. We have to be careful about how much stimulus we put into the system and how much that creates more problems with the deficit. We have to be cautious about some of the fixes, and focus more on where we can add growth to the economy.

Q: How and when to slash the nation's deficit is a hot political issue. How will the issue affect markets?

Miletti: There has been very little focus on the fact that we actually need growth in this country to help us out in the long run.

The regulatory environment is going to be key. We have to be very careful in this country how much more controls we want to put on our economy, because that in turn is going to stifle growth and hurt us more in the long run.

Doll: The regulatory and tax reform are huge issues.

Lee: If you look at 2011, we did probably have one of the biggest political crises of our generation, and the economy actually accelerated. It really speaks to the underlying strength of the U.S. economy.