Seven Reasons to Expect a Record-Breaking Year for Stocks
“A sluggish economy, political gridlock, tepid earnings, the European debt crisis, high gasoline prices…”
I can’t really argue with Barron’s depiction of the current market environment. Yet against all these seemingly negative conditions, the stock market keeps surging higher.
Can it possibly continue, though?
Well, yesterday, I produced some statistical backup, which tells us that the answer is “yes.” (In case you missed it, you can gain enlightenment here.)
Today, it’s time to focus on the fundamentals.
Sorry, bears. They point to higher prices ahead, too. All seven of them.
Take a look:
Bullish Fundamental #1: ‘Tis the Season
As fate would have it, the Dow and S&P 500 Index are approaching record highs at precisely the right time of the year.
Simply put, March and April happen to be strongly positive months for the market. In fact, they represent “the best two-month combo” over the last 20 and 50 years, based on Bespoke Investment Group’s calculations.
More specifically, over the last 20 years, the Dow has been up 70% of the time in March and April – for average gains of 1.2% and 2.71%, respectively.
So, bears, I have a question for you: “Do you feel lucky, punk?” Because that’s what it’s going to take to overcome the momentum and seasonality working in stocks’ favor right now.
Bullish Fundamental #2: It’s All About Earnings, Stupid
By now you probably cringe when I say it. But it doesn’t change the fact that stock prices ultimately follow earnings. And they’re still going up.
In the fourth quarter, S&P 500 companies reported earnings growth of 4.2%, compared to analysts’ estimates of 2.6%, according to FactSet.
And for the year ahead, analysts expect profits to grow a respectable 8.2%.
Bullish Fundamental #3: Time to Get Sentimental on You
Normally a bull market inspires optimism on the part of individual investors. But the financial crisis and ensuing market collapse left scars – horrific scars that are clearly preventing individual investors from embracing stocks for any sustained period of time. Even as prices approach near record highs.
I say that because it only took a few down days in the market for investors to abandon their optimism.
Case in point: The weekly bullish sentiment reading from the American Association of Individual Investors (AAII) plummeted over 13 full points last week, to 28.39. That’s the biggest weekly decline in over two years.
Ironically, plunging sentiment is a bullish indicator for the stock market.
As I’ve shared before, when bullish sentiment drops below 25% during this bull market – which has happened seven times so far – stocks rallied over the next three and six months every time (except once).
Long story short: Keep an eye on this week’s sentiment reading. If it dips below 25%, we should treat it as a reliable (contrarian) “Buy” indicator.
Bullish Fundamental #4: Underinvested, Anyone?
The time to worry about a market top is when everyone is invested in the stock market. That is, when stocks become a crowded trade. And that’s not even close to happening.
Consider: U.S. private pensions have only 35% of their assets in stocks, compared to the long-term average of 45%.
As far as individual investors, they’re being told to stay underinvested, too.
The latest reading of Bank of America’s (BAC) Sell Side Consensus Indicator came in at just 45.2%, compared to a long-term average of about 61% and an all-time low of 43.9%.
Bullish Fundamental #5: Less Joblessness = Higher Stock Prices
We’ll save the debate over whether or not we can trust government employment figures for another day.
Today, let’s focus on the undeniable fact that initial jobless claims exhibit a strong inverse correlation with stock prices. Historically, as claims dip, stocks rally. (See here for pictorial proof.)
And guess what? Claims keep dropping. In the last week, initial claims dropped 22,000 to 344,000.
The lower they go, the higher we can expect stocks to rise.
Bullish Fundamental #6: “Price is What You Pay. Value is What You Get.”
Long-time investors are bound to recognize the above quote from Warren Buffett. Well, Mr. Buffett still believes that stocks represent a good value.
He recently told CNBC, “We’re buying stocks now. But not because we expect them to go up. We’re buying them because we think we’re getting good value for them.”
And the data validates his assessment…
The Dow currently trades at 12.6 times forward earnings, compared to its median valuation of 17.2 times over the last two decades.
Meanwhile, the S&P 500 trades for 14.5 times trailing earnings.
If the bull market ended now, it would be the cheapest valuation at a market top in history, according to LPL Financial’s Jeffrey Kleintop.
In 2007, the S&P 500 peaked at 16.8 times earnings. And at the end of the tech bubble, the earnings multiple reached almost 30 times earnings.
So, yes, even though it sounds illogical, stocks have been going up in price for four years, but haven’t gotten expensive.
Bullish Fundamental #7: Bet on Bernanke
“Central bankers rather than politicians are the dominant driver of asset prices,” says Bank of America’s Chief Investment Strategist, Michael Hartnett.
Sound familiar? It should, because roughly four weeks ago, I wrote: “The current bull market isn’t in jeopardy of coming to an end until the Fed finally stops buying up bonds.”
The Fed still holds the key to the end of this bull market. It has no intention of letting up on the money printing yet.
So instead of fighting stock market prosperity – which is being bolstered by monetary policy – embrace it!
Bottom line: Records are made to be broken. And I don’t care if the current bull market is getting a little long in the tooth as it enters its fifth year. Given the current fundamentals, it’s destined to keep charging and set a new record. So don’t miss out!
Ahead of the tape,