Stocks Outlook: Pros See Big Gains in '12—And Big Risks

The good news is that Wall Street experts think stock prices will rise more than 10 percent next year. The bad news is that they expected big gains in 2011 and got nearly zero instead.

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It's forecasting time on Wall Street, and once again the pros are trying to predict the unpredictable. History suggests their target price for stocks by the end of 2012 will prove too high or too low. They might even get the direction wrong — predicting a gain when there's a loss.

As Yogi Berra said, "It's tough to make predictions, especially about the future."

In typical times, guessing where stocks will end up in a year is difficult. There are many assumptions about economic growth, inflation and consumer spending that go into the calculation.

Now, forecasting has become nearly impossible. Big unknowns hang over the market as rarely before. Will the euro zone break up? Will China slow too sharply? Will squabbling in Washington scuttle the economic recovery?

"Normally, you wonder, How will sales do? How are managements doing?" says Howard Silverblatt, senior index analyst at Standard & Poor's, which puts out its own forecasts. "Now there are so many high-level issues that affect the market."

Silverblatt's firm says the S&P 500 index

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[.SPX  Loading...      ()   ] should rise to 1400 by the end of 2012, up 12 percent from the Thursday's close of 1254. That figure is an average of expectations from investment strategists, economists and other big thinkers. More bullish yet are stock analysts focused on individual companies. Add up their price targets for each stock in the index, and they see it rising to 1457, up 16 percent.

There's plenty of reason to think stocks will rise fast in the coming year. U.S. companies are generating record profits. Americans are spending more than expected and factories are producing more. The job market finally appears to be healing, too.

The odds of the U.S. slipping into another recession have fallen since the summer, when the economy had slowed.

Stocks seem attractively priced, too. The S&P 500 is trading at 12 times its expected earnings per share for 2012. It typically trades at 15 times, meaning stocks appear cheaper now.

Binky Chadha, chief strategist at Deutsche Bank, says the S&P 500 could hit 1,500 by the end of 2012, a 20 percent gain.

Still, there is worry amid the bullishness.

Michael Hartnett, chief global equity strategist at Bank of America-Merrill Lynch, expects the S&P to close next year at 1350, up 8 percent from Thursday's close. He thinks the U.S. will avoid recession and U.S. companies will generate decent profits.

What could wreck that prediction is a worse situation in Europe than he is expecting. If European leaders move too slowly to solve their government debt crisis, the region could fall into a deep recession and throw the U.S. into one, too. If Europe tanks, profits will drop sharply and push the S&P down to 1,000, he says. That would be a sharp drop of 20 percent from Thursday's close.

The frightening part is that Hartnett gives this "bear" case four-in-10 odds.

Similarly, Barry Knapp, strategist at Barclays Capital, predicts the S&P will rise to 1,330 next year. But he expects Europe's struggles with its debt and Washington gridlock could lead investors to sell before they buy. He says the S&P could fall to 1,150 by the middle of the year before rising to his target.

It could drop sooner. In the first three months next year, Italy needs to sell national bonds to raise money to pay holders of $172 billion worth of old ones coming due. The risk is that investors will demand high interest rates to buy the new bonds, and that will spread fears of a possible default. After Italy was forced to pay unexpectedly high rates in a bond auction earlier this month, stocks fell hard around the world.

"The crisis could become systemic," says Athanasios Vamvakidis, head European currency strategist at Bank of America-Merrill Lynch. "That would threaten not only Europe, but the whole global recovery."

One solution is to invest in companies selling goods that people need in both good times and bad, such as drugs and food. If the economy falls into recession, profits of these companies are less likely to collapse.

In 2011, these so-called defensive companies bucked the flat market. Stocks of utility companies have risen 14 percent through Thursday. Health-care and consumer staples were each up 10. Standouts include insurer UnitedHealth Group

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[UNH  Loading...      ()   ], which has risen 40 percent, and Kraft Foods

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[KFT  Loading...      ()   ], up 18 percent.

Then again, you might do better investing in the opposite kind of companies, like makers of toys and other consumer discretionary goods. Their profits tend to zoom up and down with the economy.

A report from S&P Capital IQ notes that stocks of cyclical companies such as these tend to gain the most after market drops like the one in October, when stocks fell nearly 20 percent.

In the five times that the S&P 500 has fallen between 15 percent and 25 percent since 1978, consumer discretionary stocks have risen an average 30 percent in the next six months, according to S&P. Those stocks are up 15 percent since October's fall.

One reason it's difficult to guess future stock prices is that figuring out where the economy is heading isn't so easy either.

In December 2007, economists expected the economic to grow an average 2.4 percent in 2008, according to a survey of three dozen of them by the Federal Reserve Bank of Philadelphia. It shrank 0.3 percent instead. For 2009, they forecast the economy would shrink 0.8 percent. It shrank 3.5 percent.

Economists were more accurate the next two years, though not by much. Now they say the economy will grow 2.2 percent next year.

A few mutual fund managers say people aren't skeptical enough about forecasts. In a recent letter to their investors, the folks who run Castle Focus, a $43 million fund, say hopes of big profits may be dashed given all the economic uncertainty. The fund had 28 percent of its assets in cash in September, its latest report.

Most funds are doing the opposite and investing cash. The average stock mutual fund had just 3.5 percent of its assets in cash in October, according to a report from the Investment Company Institute. That is the nearly the lowest level since the firm started keeping records 25 years ago.

Maybe fund managers have been listening too much to bullish stock analysts. For the record, the same analysts surveyed by S&P who expect a 16 percent stock jump next year were optimistic about 2011, too. A year ago, they called for the S&P to rise 9 percent.

It still may, but the odds are long and time is running out. As of Thursday, the index was down 0.3 percent for the year.