4 Signs The S&P 500 Index Is Headed To 1,790

 |  Includes: SPY
by: Lou Basenese

As my father loves to tell me, “No matter how flat you make a pancake, it still has two sides.” Yet in the aftermath of the roughly 20% rout for the market, which erased $2.3 trillion in stock market wealth, the financial press can’t seem to remember that truth. Most keep playing up the significant burdens overhanging the market. Like out-of-control government deficits and debt, uncomfortably high unemployment, slowing economic growth and a still floundering real estate market. And they conclude the selloff that began in July is the start of a much longer and overdue downturn.

We all know that bull markets don’t go straight up forever. They’re often interrupted by bouts of volatility and rapid selling. And I’m convinced that the recent selloff was nothing more than that. A bump in the road to higher prices.

Here are four bullish signs – the “other side of the pancake,” if you will – to convince you of the same.

Bull Market Indicator #1: A Buyback Bonanza

More companies are set to buy back shares in August than in any month since the peak in 2007, according to Birinyi Associates. And research clearly demonstrates the impact of such optimism on the part of corporations. Six months after a repurchase program is announced, a company’s stock is up as much as an extra 4%, according to Allen Michel, a finance professor at Boston University.

Over the longer term, the outperformance is even more pronounced. A study out of the University of Illinois at Urbana-Champaign showed that companies buying back their own shares typically outperform the broad market over the next four years, by as much as 45%.

Bull Market Indicator #2: The Insider Connection

Corporate insiders sell shares of their company’s stock for a host of reasons. But they only buy shares for one – to make money. And wouldn’t you know it? In the aftermath of the latest market volatility, insiders are backing up the truck.

“We’re seeing the most aggressive insider buying since March 2009,” says Ben Silverman of Insiderscore.com, which tracks insider trading.

Clearly insiders believe their stocks are undervalued again. And who would know better?

Bull Market Indicator #3: A Historically Gloomy Consumer

It’s completely counterintuitive, but when U.S. consumers get the gloomiest, stocks typically rally. Specifically, research out of Ned Davis shows that when the Conference Board’s Consumer Confidence Index is low (below 66), the Dow rallies by an average of 13.1% over the next year.

Guess what? The latest consumer confidence reading was released yesterday. And confidence plummeted, with the Consumer Confidence Index dropping to 44.5 from 59.2 in July. That’s the lowest level since April 2009.

Bull Market Indicator #4: A Valuation Gap

Investing at its core is about nothing more than buying assets on the cheap and selling them for a higher price. And although it might be hard to believe, stocks are historically cheap right now. In fact, we haven’t seen stock valuations plumb such low levels in the aftermath of a recession since Ronald Reagan was president.

More than one-fifth of stocks in the S&P 500 are trading for single-digit price-to-earnings (P/E) ratios. As a whole, the S&P 500 Index recently traded at a P/E ratio of 12.9. That’s about 4% less than the average P/E ratio experienced during the 10 economic contractions since 1949, according to Bloomberg data.

On a forward-looking basis, the valuations are even more compelling. The forward P/E ratio for the S&P 500 Index stands at just 10.8. If we assume stocks will eventually revert back to their 50-year average forward P/E ratio of 16.4, it can only be accomplished in one of two ways. Either earnings have to fall to $71.76 per share for the S&P 500 Index, equivalent to a 22% decline, or the S&P 500 has to rally to 1,790, about 50% higher than current prices.

The former is completely out of the question, because S&P 500 earnings are expected to climb 13% next year, marking the fourth straight year of profit growth. And even though analysts have a terrible track record of predicting profit growth, they’re not that terrible.

Wall Street and Main Street might be overrun with gloom and doom. But the truth is, this bull market could charge another 50% higher before it dies.