December 20, 2012 6:53 pm

Fundamentals in focus for S&P 500 bull run

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Wall Street analysts are renowned for being bullish and they are not holding back for 2013.

After a year in which many were caught off-guard by a double-digit rise in stocks, top strategists and portfolio managers are no longer underestimating the resilience of US equities.

To do so though means first paring back concerns of the US markets’ sensitivity to macroeconomic events. Those concerns helped bolster the most bearish calls on earnings growth in 2012, which have proved wildly off the mark.

Adam Parker, Morgan Stanley’s chief US equity strategist, in his outlook for next year says a backdrop of macro risks remains including the US fiscal situation, the European debt crisis and a slowdown in emerging markets.

But Mr Parker, who had one of the most bearish views for the S&P 500 in 2012, says “the acuteness of these issues appears now to be less sharp”.

Strategists at S&P Capital IQ have called for a 2013 year-end of 1,550 for the S&P 500, saying stocks could still benefit if those risks recede next year.

Still, that recognition has brought some of the focus back on to company fundamentals. Earnings growth for the S&P 500 is forecast at 9.8 per cent while revenues are expected to expand 3.8 per cent in 2013, according to FactSet.

Companies on the benchmark are seen recording earnings per share of $112.70, up more than $10 from the current record level of $102.56 for 2012.

Drilling down into the average price targets of each company in the S&P 500 translates into the index rising to 1,602.47, a gain of 11 per cent from where stocks currently sit.

Yield-seeking equity investors in 2012 have shown strong interest in high-dividend paying stocks but a notable laggard has been the utilities sector. The sector has dropped 1.7 per cent so far and remains the only S&P 500 industry measure to reside in negative territory for the year-to-date.

The 31 companies in the sector group pay an average dividend yield of 4.2 per cent and strategists say that is a compelling offer for investors.

“Any income related to equity exposure is the way to go in 2013,” says Jack Ablin, chief investment officer at Harris Private Bank.

David Mertens, principal at Jensen Investment Management, says that, in the hunt by investors, large-dividend stocks provide fair value and are a good backstop for portfolios. “We prefer to favour companies that are growing their dividend,” he adds.

Jensen’s portfolio includes 29 groups that generate significant cash flow with a return on equity of more than 15 per cent in each of the past 10 years.

Those calls may prove timely if investors flee riskier assets in the event US politicians fail to resolve the fiscal cliff of spending cuts and tax rises set to kick in on January 1.

Others say even a modest deal may not prove to be good enough in the near-term, says Barry Knapp, chief US equity strategist at Barclays.

Despite a 2013 year-end forecast of 1,525 for the S&P 500, Mr Knapp warns that the first significant market move next year may well be downward, given the low probability that Republicans and Democrats settle on a grand bargain that puts the US public sector debt on a sustainable path.

To avoid that, Mr Knapp is recommending investors consider technology stocks, which are set to finish 2012 near the middle of the pack among industry groups after a sharp fourth-quarter sell-off.

To find value, he says, investors must look beyond the sector’s most favoured companies, including Apple and Google, and instead consider those that could benefit from a rebound in corporate spending next year.

That includes companies such as Hewlett-Packard and Intel, which are among the biggest laggards on the Dow Jones Industrial Average in 2012. Financials, led by regional banks, are set to notch the biggest returns for the year as accommodative Federal Reserve monetary policy has helped bolster lenders.

But after leading the industry groups on the S&P 500 for the year, the sector must overcome regulatory pressure and low interest rate constraints in 2013 to rise further.

Analysts at KBW say despite the outperformance in 2012, financials will continue to trade at a discount to long-term averages until economic growth accelerates or expectations of a rise in interest rates set in.

While rates may not move in the short run, some say an accommodative Fed may well continue to be a boon for stocks in 2013. “Investors have not had to pay a lot of attention to what they owned given all the liquidity efforts of central banks,” says Mr Mertens.

Further support for stocks may come from easier year-on-year sales comparisons after a wave of companies fell short of forecasts for 2012.

Vadim Zlotnikov, chief market strategist at AllianceBernstein, says the significant number of negative revisions in 2012 to top-line results will mean that many companies have a lower bar to cross. “In the absence of a recession, you can expect revenue growth to beat forecasts for many companies next year.”

Still, others lament the job of setting firm benchmark forecasts for the S&P 500. Mr Parker says: “We wish we didn’t have to set a year-end target. Having had a very accurate one in 2011 and a pretty bad one in 2012, we are living proof there is a negative asymmetry.”

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