The U.S. budget debate is holding stocks hostage, as chiefexecutive officers prepare to cut capital spending for the firsttime since 2009 should President Barack Obama and Congress fail toreach an accord.

Expenditures by Standard & Poor's 500 Index companies willfall 1.3 percent in 2013 after three years of growth, according tomore than 10,000 analyst estimates compiled by Bloomberg. Companiesfrom Verizon Communications Inc. to Rockwell Collins Inc. said theydon't plan to boost investment amid concern political leaders willfail to agree on a plan that would avert more than $600 billion ofspending cuts and tax increases that threaten to throw the U.S.into another recession.

Bears say CEO pessimism will sap the rally that boosted theS&P 500 12 percent this year and note that the last timecapital spending declined was at the end of 2008, just beforestocks slumped to a 12-year low. Bulls point out that estimates forcorporate spending show any decline will be limited and say theimproving U.S. economy will lift equity valuations, now 12 percentbelow the 58-year average, Bloomberg data show.

“In an environment where the economic and political outlook ishighly uncertain, it is hard for executives to make investmentdecisions,” Abi Oladimeji, who helps oversee $4.3 billion as headof investment strategy at Thomas Miller Investment Ltd. in London,said in a telephone interview on Dec. 12. “The danger is that wesee policy errors, which could undermine equity markets and thebroader economy.”

Obama, Boehner

Whatever the outcome, investors say the negotiations inWashington are the primary catalyst for investment decisions as2012 draws to a close. While the S&P 500 has risen 109 percentfrom its lows in March 2009, it is poised for the first fourth-quarter decline since 2008. U.S. stocks had the worst performanceamong 24 developed equity markets this quarter.

The S&P 500 slid 0.3 percent to 1,413.58 last week andsnapped a six-day gain after House Speaker John Boehner, aRepublican from Ohio, said again that Obama's budget proposal is“anything but” balanced. Obama said the negotiations are “a work inprogress.” S&P 500 futures added 0.1 percent to 1,410.3 at 5:21a.m. in New York today.

A Bloomberg National Poll showed a majority of Americans backObama's demand that tax-rate increases for the highest earners be aprecondition for a deal that cuts U.S. entitlement programs. TheCongressional Budget Office has warned that if talks fail, theeconomy may slip into a recession in 2013.

Reaching Compromise

U.S. leaders will reach a compromise, diminishing the impact ofany corporate spending reductions, according to Joseph Tanious, aglobal market strategist for JPMorgan Funds, which oversees $400billion. While capital spending is projected to slip, it willremain close to the high reached in 2012 of $72.8 billion, hesaid.

“These are giant question marks right now and it's feeding intothese analysts' estimates,” Tanious said by phone on Dec. 12. “Iwouldn't read into it too negatively. The opportunity movingforward in stocks is going to be multiple expansion, more so thanearnings growth. The slowdown in capital expenditures, while itcertainly depresses growth expectations, doesn't mean there aren'topportunities.”

The S&P 500 trades at 14.4 times profit for the last 12months, about 12 percent below the average for the past sixdecades, data compiled by Bloomberg show. Options prices show themost bullish outlook for the S&P 500 in the last two years.Puts with an exercise level 10 percent below the S&P 500 cost7.52 points more than calls 10 percent above on Dec. 12, the lowestsince November 2010, according to data on three-month contractscompiled by Bloomberg.

Three Quarters

Analysts following companies in the S&P 500 estimate thatcapital spending will decline 1.1 percent from a year ago to $17.2billion in the second quarter, 0.6 percent to $17.5 billion in thethird quarter and 7.4 percent to $18.2 billion in the fourth,according to data compiled by Bloomberg.

The measure has proved to be an accurate indicator for changesin corporate earnings and stock market performance. When CEOslimited expansion in 2009, the S&P 500 tumbled 12 percent to alow of 676.53 on March 9.

Analysts correctly predicted that companies would increaseinvestment after the financial crisis and the deepest recession inseven decades. Spending gained 6.2 percent in 2010, 24 percent in2011 and 15 percent this year, Bloomberg data show.

Three years of expansion coincided with 10 quarters of S&P500 earnings growth. Profits for the biggest American companies areestimated by the analysts to reach a record $114.76 a share nextyear. The U.S. stock rally is poised to reach the average length ofbull markets since World War II in April, according to datacompiled by Bloomberg.

Differing Outlooks

Forecasts for capital expansion are inconsistent. Manufacturerswill boost spending 7.6 percent next year, according to theInstitute for Supply Management's semiannual survey released Dec.11. The increase is the biggest for any December survey in at leastseven years, according to the Tempe, Arizona-based ISM.

A cross-industry survey by the Business Roundtable found morecorporate leaders see a slump. About 23 percent of members surveyedsaid their company's spending will fall in the next six months,compared with 19 percent in the prior quarter, the Washington-basedCEO association said on Dec. 12.

Executives have “slightly lower expectations for sales andcapital expenditures,” Jim McNerney, chairman of the group and CEOof Boeing Co., said in a statement accompanying the survey. “Thecontinued softness in quarterly sentiment reflects deep uncertaintyabout the future overall economic climate, realities of aslow-growing economy and frustration over Washington's inability toresolve looming 'fiscal cliff' issues.”

Fed Purchases

Federal Open Market Committee participants on Dec. 12 loweredtheir forecasts for growth next year. They now see the economyexpanding as little as 2.3 percent, compared with at least 2.5percent in September. The average pace of growth for the decadethrough 2007 was 3 percent. The economic slowdown is promptingcompanies to curtail technology spending and pushing consumers tofavor mobile devices over personal computers, eroding profitabilityat Intel Corp.

Chief Financial Officer Stacy J. Smith said in an Oct. 16 callwith analysts that the Santa Clara, California-based company willreduce investment in the fourth quarter. Analysts estimate an 11percent cut next year to $10 billion after a 7.6 percent rise in2012. The stock has tumbled 15 percent this year.

Capital Budgets

“Semiconductors in general are seeing a lower-than-normalseasonal fourth quarter because we're already feeling the fiscalcliff,” Doug Freedman, a San Francisco-based RBC Capital Marketsanalyst, said by phone on Dec. 13. “Capital budgets and people'snervousness over the ability for macro growth to continue havealready affected their spending patterns. Up and down the supplychain, we're seeing cautionary behavior.”

Clay Jones, the CEO of Rockwell Collins, said in a phoneinterview on Nov. 7 that the aerospace supplier may cut about 6percent of its workforce, or about 1,250 jobs, in part to preparefor lower military spending. Defense accounted for about 55 percentof Rockwell Collins's revenue in the fiscal year ended inSeptember. Shares are up 1.8 percent this year and 20 percent sincehitting a low in June. Analysts estimate capital expenditures willdecline 6.1 percent in 2013.

“We have no idea within the realm of 10 percent what the defensebudget of the U.S. is going to be,” Jones said in an interview fromCedar Rapids, Iowa, on Nov. 7. “I am planning for the worst.”

Verizon Spending

Verizon, the second-largest U.S. phone company, said on Oct. 18that spending for the first nine months of the year declined bymore than $1 billion from the year-earlier period. Chief FinancialOfficer Francis Shammo said last month at a conference the numberprobably won't rise in 2013.

Executives are delaying new contracts and investment decisionsdue to “the pending fiscal cliff, potential tax reform and otherpolicy changes that may take place,” Shammo said in a call withanalysts on Oct. 18 from New York.

The rate on dividends for high-income taxpayers may rise nextyear to 43.4 percent from 15 percent. More than 140 companies inthe Russell 3000 Index, which represents about 98 percent of theU.S. equity market, have declared $18.7 billion worth of specialdividends since Sept. 1, according to Bloomberg data. The payoutsare more than three times the average market value of companies inthe gauge, data show.

While distributions show corporate leaders are confident enoughto pay out some of their cash, it also signals they're notoptimistic enough to invest in larger projects, according toMalcolm Polley, who manages $1.1 billion as chief investmentofficer at Stewart Capital Advisors LLC in Indiana,Pennsylvania.

“You have a lot of companies holding off spending,” Polley saidin a Dec. 13 phone interview. “There's a real risk that capexacross the board declines in 2013.”

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