The U.S. and a Focus on Fundamentals…at Least for a While.

The recent all-time highs for several U.S. equity indices are evidence that markets have finally managed to put the dreary politics of the last couple of years in the rear-view mirror and renew focus on the fundamental strengths of U.S. businesses. Hopefully the upcoming debate over the debt ceiling and the federal budget won’t overshadow an economy that’s increasingly building momentum.

The U.S. has several very positive factors fueling its economic recovery. Manufacturing is expanding, driven by relatively low energy costs, improved productivity, and innovation. Some firms, like tech giant Apple have announced that they’ll be expanding their on-shore manufacturing presence – somewhat reversing decades of outsourcing that pushed jobs to low-wage countries. The housing market, a bellwether of previous recoveries, is clearing in many areas of the country. I find it likely that housing will contribute to overall growth in 2013, contrasting its negative effects of the last several years.

With both Democrats and Republicans unveiling their first-round budget proposals, the remainder of 2013 looks to resume the bickering that’s become all too familiar from Washington. Luckily there’s been this respite that’s allowed markets to recognize the factors underlying the recovery, and that will probably benefit several U.S. asset classes.

U.S. equities, in particular, are still not highly valued, reflecting a “lost decade” mentality. We feel that U.S. stocks still have room to move and will likely end the year higher than their current level. For the year as a whole, a reasonable expectation might be 20% in a best-case scenario. That would imply another 10% or so from where we are now. Small- and mid-cap names look poised to benefit from the current trends, especially those firms with high domestic content. Manufacturing too, including selected technology companies, could see nice increases if the recovery holds.

The job market continues its slow improvement. The government’s first estimate of February numbers put the unemployment rate down to 7.7%. While that doesn’t factor in the sequester-induced cuts that will likely trim the ranks government and government-related areas, the majority of the private sector continues to hire. When you examine that expanding work force in the light of the constraints on the supply of office, retail, and industrial space, U.S. commercial real estate also appears as an attractive investment alternative.

Fed policy seems to be in place for at least the remainder of 2013, so interest rates will likely stay low as well. That means U.S. Treasury yields will probably hover around their current levels. Fixed income investors may have to look to sectors like high yield and CMBS, with a focus on well-researched credit exposures, for their returns.