The market started up and, more importantly, stayed up on Tuesday. Some point to fresh election wins by Republicans. Some point to QE2 coming online Wednesday which is generally considered a positive for stocks. Or simply there are a lot of great fundamental reasons for stocks to keep heading higher at this time.
Here are 4 such reasons:
1) Corporate Earnings
We just came through 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 was Q3 earnings season, you ask?:
- 4.55 stocks had a positive surprise for every 1 that was negative
- The average positive surprise showed earnings 4.9% above expectations
- 1.33 positive estimate revisions ratio. Meaning estimates are moving up for the future.
- Year over year growth looks like +42%
Thanks to the strong earnings noted above, the bottoms up estimates for the S&P 500 next year currently stands at $92.27. This means that the S&P is only trading at PE of 13.1. That is very reasonable by historical standards.
Now consider the earnings yield of stocks which is dividing the $92.27 in earnings by the current S&P price level. That comes out to 7.73% which is VERY attractive compared to the meager 2.6% yield on the 10 year Treasury. This last point has been a big driving force behind the rally in stocks that takes us to where we are today. And as you can see, there is plenty of room for it to reach higher valuations without being considered too pricey.
3) End of the Bond Rally
After 30 years of the bond rally it would appear that we have reached bottom or very close to it. This is especially true if the Fed does embark on QE2. Why’s that? The Fed is concerned about deflation. So they want to spark some inflation by lowering rates on bonds. But bonds are GREATLY influenced by future inflation expectations. So if QE2 helps to spark some inflation, then by definition it will raise Treasury rates and thus end the 30 year bond rally.
When this happens, then more money will flow out of bonds funds and seek better rates of return. Given what I shared above they will be hard pressed to find a better alternative than stocks.
4) Individual Investors Ready to Get Back In
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 this year’s tremendous volatility 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. Once the market pushes to new highs above Dow 11,300 the media will make a big deal of this. Then individual investors will feel they are missing out again and will start to pile back into the market which will help fuel the next rally higher.
How high? Given the valuation scenarios I shared above we can easily make it to Dow 12,000 without being overstretched. And if the pendulum starts to swing away from fear and back to greed it could go to 12,500 or even 13,000 easily over the next 12-18 months.
I know there are many out there on Seeking Alpha who still are pounding the table about double dips or worse. The sad fact is that these “glass is completely empty” views of the world are not paying the bills. It’s not that I don’t think we have our share of troubles, its’ just that the preponderance of the evidence points to a moderate growth economy and greater gains for stocks. I hope that more of you will start to see this evidence and come along for the ride. (Double Dippers, please commence flaming my article now ;-)
My Two Cents
During the day I read many other investment articles of interest. Here are links to some new ones with my 2 cents added underneath.
Both Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG)sniffed out this thriving market early and will be prime beneficiaries of the growth in moble advertising. No need to figure out who will do better. Buy shares of both and enjoy the ride!
There is no question about "if" the 30 year bond rally will end. Only a question of "when".
I too think there are some good signs that the end of the rally is here and that is why I own shares of TBT (2X short long bonds). However, the risk is that it takes longer to happen than anticipated and if true, then TBF is the better choice.
SHOO beat on earnings, revenues and even raised guidance for the future. Yet some investors have been very nitpicky this earnings season. So with SHOO they complained about a slight lowering of margins. It's a shame they can't see the terrific sales trends and pristine balance sheet that makes this company so attractive. So I say thanks to those who sold today because they gave me another chance to buy more shares at an attractive price.
Disclosure: If I recommend them, then I generally own them. So yes, I own AAPL, GOOG, TBT and SHOO