A Bullish Look Back at 2013 From the Future

This is a hypothetical look at what might occur for the rest of 2013, as written from 2014. These are only "educated guesses," but each bullish forecast is backed by relevant data. For the bear take on the coming year, click here.

Coming into 2013, the thought of a bullish year was, at first, tough to swallow as Congress waited until after the last minute to approve legislation that addressed the fiscal cliff. As soon as Congress did approve a bill, however, the S&P 500  (SNPINDEX: ^GSPC  ) leapt nearly to all-time highs. Many thought the early bullishness would soon wear off, but as Congress worked out all the country's fiscal issues from debt ceilings to sequesters, investors gained even more confidence.

Congress does something right
After Congress extended another decision deadline for the debt ceiling, it seemed like any real decisions would be forever put off. However, senators and representatives were finally incentivized to act for the long term when their pay was on the line. With a stipulation that withheld Congress' pay if lawmakers didn't pass a budget in their respective houses, representatives approved a budget that made both sides unhappy -- a sign that it was a fair deal. The agreed-upon cuts and tax increases culminated in a dramatic photo of Obama hugging Republican Speaker of the House John Boehner.

"Uncertainty" no more
With the near-constant fog of government uncertainty lifted, companies were able to plan long-term investments, and entrepreneurs were able to expand their businesses, helping to boost job creation near levels last seen in the immediate post-recession recovery. After March, an average addition of 300,000 jobs per month lowered the unemployment rate to 7.1% by the end of 2013 -- better than any forecast had predicted.

Where did these jobs come from? The housing turnaround stuck, and new-home construction boomed as all those who put off forming households during the recession finally settled down (outside their parents' homes). Fool Morgan Housel sums up housing-related employment:

The Center for Housing Policy estimates that every new home generates 2.1 new jobs -- both directly from construction workers and real estate agents, and indirectly, as those workers spend more money. The National Association of Home Builders puts it at 3.05 jobs per new home. Whatever the true figure is, it adds up fast when we're talking about a need to build a million homes per year above current levels.

The energy industry also continued to grow in the U.S. The most notable project was TransCanada's (NYSE: TRP  ) Keystone XL pipeline, finally approved by the White House after Nebraska's governor approved an alternate route avoiding environmentally sensitive areas. The abundant energy kept energy costs low, which also helped the U.S. gain more manufacturing jobs -- many times more jobs than the 9,000 created directly by the pipeline.

Other CEOs, like that of Honeywell  (NYSE: HON  ) and Eaton  (NYSE: ETN  ) , blamed the fiscal cliff for cuts in their forecasts back in 2012. At the time, Eaton's truck, automotive, and aerospace segment revenues all fell by more than 25% in the third quarter. After the first fiscal-cliff deal, Eaton CEO Alexander Cutler told The Wall Street Journal, "This virtual rolling thunder style of negotiation and lack of progress has done nothing to reduce uncertainty -- uncertainty that continues to negatively impact investment and job growth." But with no more uncertainty, Eaton comfortably invested some of its more than $1 billion in cash and short-term investments into expanding its business.

Following the first fiscal-cliff deal, Honeywell CEO David Cote, speaking for the Campaign to Fix the Debt, said, "I still believe there's a chance for market confidence and stability in 2013, which will help to create jobs and deliver a more robust economic recovery." He was right. The uncertainty that hung over the market since the failure of the supercommittee back in late 2011 disappeared, leading to another market bounce like that which followed the first fiscal-cliff deal in January.

As Bank of America, Citi, Oppenheimer, and BMO analysts had forecast, the S&P 500 ended 2013 around 1,600 points, up about 12% for the year -- slightly above an average year's return for the index. While the index's Shiller P/E in early 2013 of 17 was still above the historical average of 15, stocks still did not return to the mean in 2013.

The resulting Federal Reserve move
The much-improved economy brought into question when the Federal Reserve would raise rates. Inflation averaged around 2% for the year, and unemployment was nearing the Fed's target level of 6.5%, but this milestone was coming much sooner than 2015, when the Fed originally predicted it would be attained -- definitely a surprise. By the end of 2013, the market began pricing in a rise in interest rates.

While higher rates would help companies like Paychex and Automatic Data Processing, which could earn more interest on the money they hold between taking it from employers and doling it out to employees, it could hurt others. Specifically, mortgage REITs, which would face higher borrowing costs once interest rates rise. Annaly Capital Management  (NYSE: NLY  ) had a string of dividend reductions in 2012 as its interest rate spread fell due to lower yield on assets, even while its cost of borrowing remained unchanged. And with 2013's booming economy portending a rise in borrowing costs, the large yields of mREITs look to be in trouble with a newly bullish Federal Reserve.

A hypothetical journey
Forecasts are nearly impossible to get right, as you have to guess not only what will happen but when. Through this exercise, though, it seems the biggest issue challenging a bull market appears to be whether Congress can come to an agreement.

What else might 2013 have in store for Annaly Capital Management? In this brand new premium research report on the company, our analyst runs through these absolute must know topics, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.


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