2013 outlook: Love risk by managing it

The bottom line

With all the volatility in the markets during 2012, some investors might have forgotten that 2012 was actually a pretty good year for the bond and stock markets. There were lots of political changes—the U.S. election, the 18th Party Congress in China, and the Japanese election, to name just a few.

The year 2013 will also be host to a number of political changes that could move markets—the Italian election, the Iranian election, and the German election, to name just a few. The prospect of these changes could frighten some investors. However, we’re still forecasting moderate U.S. and global growth against the backdrop of mild inflation. That’s why we think investors who focus on risk management instead of risk avoidance could enjoy decent returns in 2013.

We expect 2013 to be a notable year for equities. Our year-end target of 1,600 for the S&P 500 Index implies only a 14 times to 15 times trailing multiple on our predicted $111 in earnings for this year and less than a 13 times multiple on our 2014 predicted earnings of $125. No doubt, the year will be filled with surprises, but given the level of concern among investors, we suspect the majority of true surprises will be positive. We also expect the world to continue to work through its problems and think that some of the fruits of those efforts will appear in the next 12 months.

Even after four years of generous returns from virtually every segment of the bond market, we continue to believe that it is still too early in this investment cycle to be in cash and cash equivalents. Because this is such an unusual business cycle, most fundamentals continue to suggest that short-term rates will stay low for at least another year, keeping returns from cash equivalents near zero. More importantly, low short-term rates tend to prevent bond yields from increasing substantially, especially when yield curves are already quite steep. Continued sizable purchases of notes, bonds, and MBS by the Fed should also help keep most bond yields within relatively narrow trading ranges.

Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses.

Mutual fund investing involves risks, including the possible loss of principal. Funds that concentrate their investments in limited sectors may be susceptible to financial, economic, or market events affecting those sectors. Consult a fund's prospectus for additional information on risks.

The views expressed are as of 12-18-12 and are those of Chief Portfolio Strategist Brian Jacobsen; Chief Equity Strategist John Manley; Chief Fixed-Income Strategist James Kochan; and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.