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This Chart Holds the Key to the End of the Bull Market

Forget words. Sometimes all we need to answer a question is a chart. And I wish I had the chart below at my disposal last week.

Why? Because I’m convinced that it holds the key to the end of the bull market.

(Hint: It’s not coming anytime soon.)

Let me explain…

Leave it to the Fed

Last week, I had the pleasure of appearing as a guest on S&A Investor Radio with Frank Curzio.

Aside from talking about all things tech, he asked me to share my outlook for stocks in 2013. (If you’re interested, you can check out the full interview here.)

It should come as no surprise to anyone here that I’m bullish. But when Frank pressed me to justify my rosy outlook, I simply responded by saying, “Don’t fight the Fed!”

As we all know, money printing always leads to inflation. It’s just a matter of figuring out which assets get inflated. This time around, gold is not the only beneficiary. Stocks are, too.

And this handy chart proves it.

As you can see, the current bull market officially began right after the Fed ramped up its purchases of government debt and mortgage-backed securities.

Was the Fed simply the match that lit the fuse? That might be true if the Fed had actually stopped buying bonds. But it didn’t.

In reality, the Fed has done nothing but buy more and more bonds over time. And, sure enough, stock prices marched higher in near perfect unison with the additional quantitative easing (QE).

Considering that Ben Bernanke is still cranking out the Benjamins nonstop – to the tune of $85 billion per month – we shouldn’t expect the bull market to end anytime soon.

Of course, I never rely on a single indicator to guide my investment decisions. So for good measure, here are three more reasons to be bullish on stocks in 2013.

~Reason #1: We Can Still Buy Low

Despite more than three years of advancing prices, stocks remain a relative bargain. Case in point: At the end of January, the price-to-earnings (P/E) ratio for the S&P 500 Index stood at just 14.9. That works out to about a 25% discount to the historical average since 1980.

~Reason #2: Sentiment is (Finally) Improving

After years of doubting the rally – and missing out on the gains – individual investors are finally feeling optimistic about stocks. As Eric Johnston, Managing Director at Barclays (BCS), told Bloomberg, “Optimism is significantly returning to the market.”

The data backs him up, as well. Two weeks ago, the weekly survey from the American Association of Individual Investors revealed that bullish sentiment topped 50% for the first time in a year.

Fear not, though. We’re nowhere close to the danger zone of too much bullishness.

Since the current bull market began, bullish sentiment topped 50% on 14 other occasions, based on my review of the data. And each time, stocks rose over the next three months by an average of 5.3%.

~Reason #3: From Feeling Good to Redeploying Capital

Investors aren’t just feeling more upbeat about stocks. They’re behaving like it, too.

Since January 1, they’ve plowed $39 billion into equity funds, according to fund flow tracker, EPFR Global.

Again, the sudden shift shouldn’t cause any concerns.

Since 2008, investors withdrew about $365 billion from stock funds in the United States, based on calculations by Nicholas Colas, Chief Market Strategist at ConvergEx Group. That means there’s conservatively about $325 billion in capital still waiting to be reallocated into stocks – more than enough “dry powder” to push prices considerably higher from here.

Bottom line: The current bull market isn’t in jeopardy of coming to an end until the Fed finally stops buying up bonds. And there’s no indication that day is coming anytime soon.

So don’t fight the Fed. Instead, keep taking advantage of the relative bargains and investors’ changing attitudes toward stocks. Just remember to protect your downside by using trailing stops.

Ahead of the tape,

Louis Basenese