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Housing and jobs key to lifting S&P toward record

Wednesday - 1/2/2013, 6:20am  ET

FILE - In this Tuesday, Oct. 23, 2012 file photo, specialist Peter Elkins, foreground, is reflected in a trading post monitor as he works on the floor of the New York Stock Exchange, in New York. If Washington lawmakers can get past the “fiscal cliff,” many analysts say that the outlook for stocks in 2013 is good, as a recovering housing market and an improving jobs outlook helps the economy maintain a slow, but steady recovery. (AP Photo/Richard Drew, File)

STEVE ROTHWELL
AP Business Writer

NEW YORK (AP) -- It may be a big if, but assuming Washington lawmakers can get past the "fiscal cliff," many analysts say that the outlook for stocks next year is good, as a recovering housing market and an improving jobs outlook helps the economy maintain a slow, but steady recovery.

An advance of 10 percent in 2013 would send the S&P 500 toward, and possibly past, its record close of 1,565 reached in October 2007.

A mid-year rally in 2012 pushed stocks to their highest in more than four years. Both the Standard & Poor's 500 and the Dow Jones industrial average gained in 2012. Those advances came despite uncertainty about the outcome of the presidential election and bouts of turmoil from Europe, where policy makers finally appear to be getting a grip on the region's debt crisis.

"As you remove little bits of uncertainty, investors can then once again return to focusing on the fundamentals," says Joseph Tanious, a global market strategist at J.P. Morgan Funds. "Corporate America is actually doing quite well."

Although earnings growth of S&P 500 listed companies dipped as low as 0.8 percent in the summer, analysts are predicting that it will rebound to average 9.5 percent for 2013, according to data from S&P Capital IQ. Companies have also been hoarding cash. The amount of cash and cash-equivalents being held by companies listed in the S&P 500 climbed to an all-time high $1 trillion at the end of September, 65 percent more than five years ago, according to S&P Dow Jones Indices.

By the time trading ended Monday, Republicans and Democrats still hadn't reached a budget compromise -- but investors were betting that they would -- after President Barack Obama said that a compromise was "within sight," but not finalized. Without a budget agreement, millions of Americans face the prospect of higher taxes and the government would be forced to slash spending, measures that would probably push the economy into recession, economists say.

Assuming a budget deal is reached in a reasonable amount of time, investors will be more comfortable owning stocks in 2013, allowing valuations to rise, says Tanious.

Stocks in the S&P 500 index are currently trading on a price-to-earnings multiple of about 13.5, compared with the average of 17.9 since 1988, according to S&P Capital IQ data. A lower-than-average ration suggests that stocks are cheap.

The stock market will also likely face less drag from the European debt crisis this year, said Steven Bulko, the chief investment officer at Lombard Odier Investment Managers. While policy makers in Europe have yet to come up with a comprehensive solution to the region's woes, they appear to have a better handle on the region's problems than they have for quite some time.

"There is still some heavy lifting that needs to be done in Europe," said Bulko. Now, though, "we are dealing with much more manageable risk than we have had in the past few years."

Next year may also see an increase in mergers and acquisitions as companies seeks to make use of the cash on their balance sheets, says Jarred Kessler, global head of equities at broker Cantor Fitzgerald.

While the number of M&A deals has gradually crept higher in the past four years, the dollar value of the deals remains remains well short of the total reached five years ago. U.S. targeted acquisitions totaled $964 billion through Dec. 27, according to data tracking firm Dealogic. That's slightly down from last year's total of $1 trillion and about 40 percent lower than in 2007, when deals worth $1.6 trillion were struck.

M&A deals are good for stock prices because the acquiring company typically pays a premium for the one it's buying.

Falling interest rates also set off a rally in the bond market. Concerns about swings in stock prices prompted investors to switch money out of stocks and into bond funds. If investors decide that the bond rally may be nearing an end, that flow of funds may be reversed, providing a support for stocks.

"Equities are the best house in a bad neighborhood," says Cantor's Kessler. "Bonds are, not priced to euphoria, but they are definitely rich compared to equities right now."

Not all investors are as sanguine about the prospects for 2013.

The rally in stocks in 2012 had less to do with company earnings and the economy and more to do with monetary stimulus from the Federal Reserve and other central banks around the world, says David Wright, a managing director and co-founder at Sierra Investment Management in Santa Monica, Calif.

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