Right now there is only 1 catalyst for US stocks: the European Debt Crisis.
Day after day our markets follow suit with theirs. That’s because a disorderly default in Greece would spread panic throughout the continent. One by one the other weak nations (read: Italy and Spain) would come to the same horrible fate. This would most definitely send recessionary shockwaves around the world…including the good ol’ US of A.
But There Is Hope.
In fact, just a week ago there was a deal on the table to contain…or at least reshape…their problems in a way that could have easily been swallowed by the global economy. That is why US stocks recently sprinted to their highest levels since July.
We can get back there again. Better yet, we can push to new highs IF Greece accepts the bailout deal bringing calm to the Eurozone and a renewed focus as to the attractiveness of the US stock market.
Here are 5 reasons why that event would lead to US stocks making new highs:
1) GDP is A-OK
Forget the horrible headlines. That’s just the media playing on people’s fears. GDP growth is accelerating. Yes, accelerating.
Q1 came in at a meager +0.4%. Q2 ratcheted up a notch to +1.3%. And Q3 nearly doubled the pace to +2.5%. As you will see that was plenty good enough to help with the next reason…
2) Healthy Corporate Earnings
We are in the midst of another strong earnings season. And the simple fact is that the health of corporate earnings has more to do with the movement of stock prices than any other measure. (If this is news to you, then perhaps you forgot that buying stocks is about buying an ownership stake in a company. And owners of companies don’t care about the “chart pattern” of the stock price. They care about the stream of earnings they will receive in the future.)
So how good is Q3 earnings season, you ask Here are the results to date for S&P 500 stocks:
- 3.12 stocks had a positive surprise for every 1 that was negative
- Year over year earnings growth is +17.6% on healthy revenue increases
- Expected EPS for the S&P 500 in 2012 = $106. That’s an impressive +11.5% increase over 2011 levels. And helps to set things up for the next reason…
3) Stocks Are Cheap
Given that analysts see no recession on the horizon, they are still comfortable with growth prospects into 2012. As noted above, that equates to a $106 per share earnings estimate for the S&P 500 next year. Which means the S&P is only trading at a PE of 11.8. That is VERY attractive compared to the historical PE norms of 14-15. This paves the way for the next reason…
4) Stocks Best Investment Alternative
Most of the tricks up the Fed’s sleeve to bolster the economy have been aimed at lowering bond rates. In fact, since 2008 they have been nearly cut in half with the 10 year note now yielding just 2.1%.
This strategy makes holding bonds and cash very unattractive given their meager returns. Conversely it makes stock ownership VERY attractive as can clearly be seen with the earnings yield of 8.4%. (You get the earnings yield by flipping the PE on its head. Just divide the $106 in earnings expected for next year by the current S&P price level).
Traditionally the earnings yield for stocks is only 3% higher than the 10 Treasury rates. As you can see the spread is nearly double that size now. This sets the table for our final reason…
5) Tons of Cash on the Sidelines
Survey after survey shows that the average individual investor has been scared out of the stock market given the precipitous drop after the Financial Crisis. Then toss in the tremendous volatility the past two years and you can understand why they’ve been saying “No Thanks!” to stocks for a while. But given human nature they won’t stay away for long.
With cash and bonds so unattractive, there will be a natural pull back towards stock ownership. As we bubble up to new highs, the media will start making a big deal about the stock market once again. The more this message gets out there, the more individual investors will feel they are missing out. As they pile back into stocks it will fuel the rally higher, which will pull even more investors back into the market.
How High Can the Market Get
Given the historical PE norms of 14-15 I shared above, we can easily make it to S&P 1400 without being overstretched. And if the pendulum starts to swing away from fear and back to greed, it could go well above that level over the next 12-18 months.
What to Do Next
The pivotal issue is that we need the European debt situation to get contained. That is no small feat, but most members of the European Union are showing great resolve to make sure that is the case. We may be to that point sooner than you realize. Once that is sewn up, it’s time to go 100% long stocks.
I realize it sounds like you can just buy any stock and you will profit from this future rally. Certainly the rising tide usually lifts all boats…but some boats do a lot better than others.
First, you need to focus on companies exceeding earnings expectations each quarter, which leads to higher estimates from analysts. This in turn leads to higher investor interest and a higher share price.
Second, keep an eye on valuations. Yes, I noted earlier that the overall market was reasonably priced. However many groups, especially large caps and safety-oriented stocks, are overpriced right now. So only select those stocks that are trading at discounts to peers.
These are exactly the kinds of stocks that I focus on in my personal trading account and share with the members of the Reitmeister Trading Alert.
Yes, I put my money right alongside yours so we are in the same boat together. (I really have a problem with those in this industry who give recommendations and don’t put their own money at stake. I will never understand that).
So if you are interested in seeing the trades I am making now, then be sure to click the link below since this portfolio will be closed again Saturday November 5th at 11:59 PM.
About Reitmeister Trading Alert
Wishing you great financial success,
Steve
Steve Reitmeister has been with Zacks since 1999 and currently serves as the Executive Vice President in charge of Zacks.com and all of its leading products for individual investors. He is also the Editor of the Reitmeister Trading Alert Service.
