The S&P 500: How Much Higher Can it Go?

Not much, say the folks at Capital Economics.

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Sure the S&P 500 has gained 0.4% to 1,750.96 at 12:55 p.m., and traded another new high today. But there are reasons to doubt the benchmark’s ability to head much higher, writes Capital Economics’ Jessica Hinds. Three of them in fact. She writes:

Tuesday's jobs data make it less likely that the Fed will start reducing its purchases in December. And the central bank's balance sheet will continue to expand even after it eventually begins to taper, which might lend some ongoing support to equity prices. However, it is still only a matter of time before unconventional monetary stimulus ends.

What's more, the S&P 500 has risen a long way since early 2009, with the result that the cyclically-adjusted price/earnings ratio has more than doubled to a level that is well above its long-run average. Profit margins are also stretched and long overdue a cyclical correction. These headwinds should cap the upside for US equities over the next year.

Finally, some unexpected event may also dull investors' appetite for risk, such as the recent debt-ceiling crisis. Indeed, this crisis has only been temporarily resolved and could well resurface next year.

In a note from Friday, however, Deutsche Bank’s David Bianco offered a different take–namely that stocks are heading higher:

We expect a further low volatility climb to 1800 by mid 1Q. While risks remain given a full year budget yet to pass and a Fed yet to taper, investor nerve for risk appears battle hardened and emboldened by the S&P’s many advances. The last course of 2013′s feast might be a rationed serving, but it’s best not to refuse and we expect healthy S&P returns in 2014 and 2015. We were disappointed with the mere stopgap fiscal deal reached this week, which may cap the S&P at 1800 until resolved, but profits trump politics and China trumps Congress. 3Q EPS and China’s momentum justify 1800 soon.

The S&P 500 is getting a boost today from Alcoa (AA), which has gained 4.1% to $8.95 after it announced a joint venture aimed at the aerospace industry, Forest Labs (FRX), which has climbed 3.8% to $56.01 after reporting better-than-forecast earnings and guidance and Freeport-McMoran Copper & Gold (FCX), which reported better-than-expected earnings and said it would seek significant cost cuts.