Stocks and bonds: The year-end outlook

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The stock market and interest rates will grind higher next year, taking the S&P 500 index to 2,000 or higher, but keeping 10-year Treasuries below 4 percent, Federated Investors strategists forecast Thursday.

They told a gathering of institutional investors and investment consultants that equity investors will see double-digit returns that are about half of what the market provided this year and predicted that a measured increase in interest rates will still yield opportunities for selective bond investors.

"The easy money has been made, but not all of the money has been made. It's going to be more of a grind," Philip J. Orlando, chief equity market strategist for the Downtown investment firm, said during a presentation at the Duquesne Club, Downtown.

Mr. Orlando forecast 2014 stock returns of 10 to 15 percent vs. the 29 percent total return the market has generated so far this year. The S&P 500, which finished Thursday at 1,775.50, could hit 2,000 to 2,100 next year, he said. He cautioned that there will be some retreats along the way and advised investors to reserve some cash for those buying opportunities.

The advance will be fueled by earnings growth and higher price-earnings ratios, which are a measure of how much investors are willing to pay for a company's earnings. Price-earnings ratios tend to rise in low-interest rate, low-inflation environments, something Mr. Orlando expects the market will continue to benefit from next year.

The price-earnings ratio of the S&P 500, currently about 15.5, will increase to about 18 over the next several years, he predicted.

R.J. Gallo, head of Federated's municipal bond group, said a number of factors will prevent interest rates from rising sharply in 2014, including stubbornly high unemployment and excess production capacity.

He forecast 10-year Treasuries, currently yielding about 2.9 percent, will top 3 percent and could reach the high 3s. That will hurt bond investors some. But Mr. Gallo does not expect the increase to be as sharp as the run up in interest rates in May, when Federal Reserve Board Chairman Ben Bernanke signalled the central bank could begin backing off of its $85 billion monthly purchase of federal securities.

He said the expected rise in interest rates justifies carrying a smaller percentage of bonds in portfolios, but cautioned against dumping them altogether.

Mr. Gallo said Federated is overweighting high-grade corporate, high yield, emerging market and international bonds as well as commercial mortgage-backed securities, which are linked to loans on commercial property. The firm is lightening up on Treasury securities as well as mortgage-backed securities, he said.

Len Boselovic: or 412-263-1941.

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