Written by Nathan White, Chief Investment Officer of Paragon Wealth Management

Overall, we currently see a positive year in 2013 for equity
markets.  The negative effects of higher
taxes and somewhat lower government spending will be offset by improved
corporate spending and economic growth as the year goes on.  Companies and consumers have been cautious
now for years and that could finally reverse in 2013 resulting in better
economic growth.  This could help the
market’s current low to medium valuation multiple to expand thereby benefitting
stocks overall for the year.  The Fed
should stay in continued easing mode as they try to boost inflation.  Government policy wants you to spend not save.  We remain cautious on bonds and are still
avoiding Treasuries and long-dated maturities.
The risk for reward is still very unattractive in this area.  There will be the usual ups and downs
throughout the year and the now seemingly ever present uncertainty caused by
government action and policy will continue to be over the market’s shoulder.

Starting to Look Abroad

It’s has been awhile since we have had a significant
position in foreign markets.  We have
been waiting patiently since the financial crisis for the emerging markets to
reassert themselves and it looks like the time has finally arrived – or at
least started to.  The reason this
excites us is because the inherent growth story associated with emerging market
countries is now coupled with attractive valuations.  The past few years have seen the U.S. market
outperform on a relative basis.  In fact,
the S&P 500 has returned about 18 percent for the last two years while the
MSCI Emerging Markets Index was down over 3 percent.

We are seeing signs that the tide is starting to shift.  Over the last three to six months the
emerging markets area has outperformed the S&P 500 on a relative
basis.  The deceleration in growth rates
for many emerging market economies appears to be stabilizing.  Chinese manufacturing PMI improved for the
fourth month in a row in November to the highest figure in seven months.  This adds to the evidence that the Chinese
economy is on the mend and starting to recover.
By the way, when I say recover, I mean returning to an 8% growth
rate.  Due to their stronger fiscal
situations, many emerging market countries have more flexibility in enacting
economic stimulus measures.  Recent moves
by many countries indicate that they are starting to move more aggressively on
this front.  Brazilian policy makers
recently cut reserve requirements for lenders to stimulate investment in Latin
America’s largest economy.  The recent
leadership change in China has heightened speculation that more measures will
be introduced to boost consumption.

Growth Potential

The main reason why emerging markets matter is because of
their growth potential. Stronger economic growth turns into strong earnings
growth over the long term and that is what ultimately drives stock prices
higher.   Over 80% of the world’s population lives in
emerging markets and their workforces are young and increasingly educated.  These economies experience a structural change
as middle classes emerge with individuals achieving rising levels of
wealth.  They are often rich in resources
and labor.  Their gross national incomes
and per capita incomes are small compared with developed economies.  As these countries open their economies and
enact policy reform there is dramatic potential for their incomes to
climb.

Compared with developed markets, emerging markets have
historically had greater return and volatility.  The volatility rises from the ever present
risks inherent with emerging markets:
political uncertainty, regulatory and corporate governance issues, and
the dominance of state owned firms.  Because
of these factors, investors demand greater return to compensate for the
heightened risks.  The higher volatility
normally associated with emerging markets will still be a factor going
forward.  In addition, the currencies of
many emerging market countries could strengthen on a relative basis due to
their stronger fiscal situations offsetting some of the possible advantage.

Normally, stocks or sectors with higher growth rates command
higher valuations.  Emerging markets
currently have higher growth rates and lower valuations.  This spells opportunity.  The current price to earnings multiple for
emerging markets is about 11 compared to 14 for the S&P 500.  This is about a 27% difference and indicates
some of the relative value that we believe exists in this area.  These low valuations could help to cushion any
downside if markets fall and provide more upside if markets rally.  The main reason that valuations in emerging
markets have come down is because their growth rates have come down from the
lofty levels usually experienced when growth first kicks in. Part of the reason
for the slowdown has been from the effects of the worldwide recession which
emerging markets are not immune from.
However, part of the slowdown comes as these economies start to develop
more domestic demand and transition from relying primarily on exports.   For
example, China and India had growth rates of 14% and 10% respectively in 2007.  Those rates have now come down to 8% for
China and about 5.5% for India.  By
comparison, U.S. GDP growth estimates are currently around 2.5%.  On the whole, we believe the better growth and cheaper valuations of emerging markets offer a
compelling opportunity compared to the risks.

Other Areas of Focus

Closer to home, the U.S. sectors we like are healthcare and
some of its sub-industries such as healthcare providers and
pharmaceuticals.  The financial sector
looks favorable as it has gone through years of cutting costs and employees and
is no longer burdened by toxic assets.
This could set the area up for better profitability going forward.  We see other intermittent opportunities in
technology, homebuilders and energy throughout the year.   As U.S. fiscal contentions could last all
year with no quick fixes it might be time to look outside the U.S. for the best
relative opportunities.  U.S. valuations are
reasonable at current levels considering artificial low interest rates.  Retail investors are still woefully
underinvested as they continue to fight the specter of 2008.  This bodes well for equity markets overall
and emerging markets in our opinion could be one the best areas of the
market.

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.