Investment advisers expect U.S. stock-market gains Planners adding to small-caps; see falling energy prices, higher interest rates

By Jonathan Burton, MarketWatch

SAN FRANCISCO (MarketWatch) -- Investment advisers are more upbeat about U.S. stocks, with many boosting small-cap holdings and trimming exposure to bonds and large-cap international stocks, according to a survey released Monday.

The July poll of 1,010 financial advisers by brokerage firm Charles Schwab & Co. Inc. found 58% of investment professionals expect the Standard & Poor's 500 Index

to gain ground this year, up from 46% in the previous survey in January.

About four in 10 advisers said the benchmark index would rise as much as 10% by year-end compared with 35% who thought that at the beginning of 2008, while a more bullish 19% expect gains greater than 10%. In January, 11% expected such a leap.

"There's certainly more optimism," said Bernie Clark, a senior vice president at Schwab Institutional. Still, he noted, it's cautious optimism: "They know there are challenges ahead."

Those challenges over the next few months include higher inflation and unemployment, a view shared by 79% of respondents. More than half anticipate the Federal Reserve will hike interest rates, a sharp turnabout from January when just 6% predicted such a move.

Those dark clouds were mixed with some bright rays, with 57% of advisers seeing lower energy prices in six months versus 42% who said that in January. About 71% said the housing market will continue to soften, but that's down from 81% at the beginning of the year.

"The market will be bottoming from here," said Tom Meyer, chief executive of investment advisory firm Meyer Capital Group in Marlton, N.J., who added that he believes the U.S. economy is in recession. Yet many stocks hold their own in downturns, he noted, and rally as investors look ahead to recovery.

"Right now the market is not overly valued," said Meyer, who participated in the Schwab survey. "It's not incredibly cheap, but this is not 2000," when many stocks traded at lofty heights.

Big hopes for small-caps

In an uncertain market climate, where to invest and how to meet clients' needs are a struggle for investment professionals. Some 77% say it will be difficult to achieve clients' investment goals in the next six months, and 49% say clients have requested more conservative options. Schwab's semiannual poll, called the Independent Advisor Outlook Study, was conducted from July 8 to July 20.

Accordingly, many advisers are making tactical adjustments to clients' portfolios.

The biggest change by far is a shift to U.S. small-cap stocks. Twenty-two percent of advisers plan to invest more in the area, up from 9% in January. And where 38% said in January that they would invest less in small-caps, only 19% would do so today.

International small-caps are also grabbing more attention. About 14% of respondents will invest more here, up from 12% in January. Also, 14% will allocate more money to emerging-market small-caps, versus 11% in the prior survey.

Meanwhile, about 30% say they'll invest more in large-cap U.S. stocks, little changed from their response in January. The percentage of advisers intending to boost cash levels declined to 22% from 28%, a positive sign for stocks.

Advisers are less sanguine about international large-cap stocks and are pulling back. Twenty-one percent said they'll buy more of these securities, down from 29% previously.

With stocks gathering more support, bonds are losing appeal. One in five advisers will invest more in bonds in the next six months, compared to 27% who planned to do so in January.

"It's been a difficult 12 months," said John Krambeer of Camden Capital Management in El Segundo, Calif. "There are some big domestic issues out there. On the other hand, much of that is built into the market, and I do think from these levels we could have a nice bounce."

Banking on financials, Canada, Brazil

The study showed that energy is expected to be the best-performing sector over the next six months (at 38% of advisers, up from 35% in January). Technology (33% versus 27%) and health care (33% versus 46%) tied for second. Consumer staples, with its relative stability and predictable earnings, was the fourth-most appealing sector, with 31% choosing the category versus 35% in January.

The financial-services sector is gaining surprising strength among advisers. About 27% tagged it as a top performer, up from 24% in January and 17% a year ago.

Advisers are much less upbeat about the telecom sector, which 10% see as having the best prospects, and consumer discretionary, where 9% are so inclined.

Internationally, Hong Kong rates as the best developed market over the next six months among 29% of advisers, but that's down from 35%. Canada is making a strong run, mentioned by 27% of advisers compared with 20% in January. Japan tied with Canada in the poll, followed by Singapore at 23%.

Support for most European markets continues to wane. Just 11% of advisers see Germany in the No. 1 spot, down from 14% in January. The United Kingdom is the favorite of only 9%, down from 11%.

Among emerging markets, 42% of advisers give the highest score to Brazil, up from 33%. But enthusiasm has deteriorated for the once-hot markets of India and China (tied at 28% compared with 36% for each in January).

"We want a good portion of our money invested in the international markets," said Krambeer, the California adviser and a survey respondent. "We're in a lower-than-average return cycle for domestic stocks. I don't think we're going to get back to the glory days. You have to look elsewhere for return."

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

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