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Stock markets are off and running in 2013 with the S&P 500 already up 5.4% so far this year, closing above 1500 points, its highest level in more than five years. Investors are expressing increasing confidence about global economic prospects, which is evident in declining U.S. equity correlations and low volatilities. Commodity prices have also firmed, with Brent crude closing above $113 per barrel as Markit’s advanced gauge of manufacturing activity in China hit two-year highs.

Sentiment has turned positive lately by better economic data from the U.S., China and the Eurozone; fading U.S. budget woes and the continued support by ultra-loose monetary policy from many of the world’s major central banks. Also supporting the rally is Japan, the world’s third-largest economy, which finally appears serious about reversing decades of lacklustre performance. The relative calm in the Eurozone has seen the euro appreciate against the U.S. dollar, while hitting a year high against a weak sterling. With the U.K. bracing for a triple-dip recession, sterling is likely to remain under pressure for some time. There has only been one quarter of economic growth in the past five and the U.K. economy is now 3.3 percent smaller than at the start of the financial crisis in 2008.

The kick-start that the British economy got from hosting the Olympic Games has all but disappeared. Figures released Friday by the Office for National Statistics (ONS) showed gross domestic product fell by 0.3 percent in the fourth quarter of 2012, compared with the previous quarter. That was a worse reading than predicted by most economists and showed flat economic growth for the country for all of 2012. Severe snow is now threatening to extend the gloom into the first quarter of 2013.

By almost any measure, Britain’s economy faces big challenges. But in the U.S. the data has turned decidedly more bullish. The debate in the Federal Open Market Committee over when to end quantitative easing (QE) and calmer international waters have resulted in higher correlations between the U.S. dollar and surprises in the domestic data than at any time since 2011.

U.S. auto sales surged to a half-decade high in 2012 with a seven percent boost in auto output in the last two months of the year. But the good news for automakers and auto parts companies may not be over with the Fed’s latest survey of auto loan conditions easing for a seventh straight quarter and resurgent homebuilding clearly helping to boost car sales. The rally in car sales is unlikely to run out of gas anytime soon as average U.S. vehicle age is still hovering around the 11 year mark. This coupled with continued strong job growth should support vehicle sales in the 15 to 16 million pace in 2013.

The S&P 500 is on pace for its best performance since 1997’s rise of 6.1 percent. Leading the pack are sectors that are barometers of the economy's future prospects, with materials, energy, financials and consumer discretionary shares up sharply. Also adding to the bullish tone is a better-than-expected fourth quarter earnings season and executive optimism. Good news out of Washington is also helping with the vote by the Republican controlled House to delay a showdown over the debt ceiling until May.

Volatility has slid to its lowest level since mid-2007 as investors have become bullish on stocks. Meanwhile, money has started to flow back into equities, suggesting that a great rotation out of bonds and into stocks may finally be starting in 2013, after five years of outflows from stock mutual funds.

For my money the best place for your investment dollar in 2013 is likely to be U.S. stocks, particularly those that are domestically focused. As investors have become more optimistic about market prospects, they have focused once again on globally sensitive stocks that outperformed in the previous cycle. But history is unlikely to repeat again.

While international growth rates are higher than U.S. growth rates on an absolute basis, recently international growth rates have decelerated while the U.S. economy has shown steady more consistent growth. The domestic-focused sectors poised for strong out-performance in 2013 are Energy, Information Technology and Industrials which should be market leaders as the year unfolds.

 

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