Late last year I lifted my target for the S&P 500 to 1375 by the end of the first quarter. Creating targets of course are fraught with peril. Surprise events can radically re-shape markets, however they are nevertheless useful as it forces us to synthesize our ideas and focus on a probable outcome.
I now feel I can extend my forecast to the end of 2012.
The road to 1500 will be anything but smooth. At times you will feel like you are on a stagecoach. There will be huge speed bumps and many detours along the way but let's look at the road map and the likely signposts along the way.
Reduced Volatility - VIX 1 Year
The biggest worry over the last 2 years has been Europe. When Berlin sneezed we caught the cold. When all hope seemed lost suddenly U.S. markets started to decouple from the European tragedy and investors started to turn their focus to improving fundamentals here in the U.S.
Last summer when Europe was falling apart and we were hitting new lows volatility as seen here in the VIX started to spike dramatically. This is often the picture we get at market inflection points. Despite the strong rise so far this month volatility has remained subdued which is certainly important to investor psyche. When investors feel the markets are nothing more than a casino they pull back.
Improving Job Market
I've pointed out in "The Holy Grail" the importance of the jobless claims numbers as a better indicator of the direction and health of the job market. This indicator has been steadily declining since the market bottom of 2009. It possesses a strong inverse correlation with our markets.
Last year was the market for dividends. As Barron's points out in its feature article this weekend "In Search of Yield" money has been pouring into equity income funds. With treasuries and high quality corporates offering next to nothing investors demanding income are starting to turn to stocks. They also point out S&P 500 companies are spending more than $2 on buybacks for every dollar in dividends. I suspect that ratio will change dramatically over the next few years.
Most corporations are terrible buyers of their own stocks. It is often done to merely offset dilution from stock options. (That's another corrupt black hole I will go into another time) The Barron's article suggests that cash rich S&P 500 companies should start to focus on a 4% yield.
Even Tim Cook CEO of Apple (AAPL), which is sitting on a giant cash hoard, is starting to understand that one of the reasons AAPL trades at such a low PE is their reluctance to share the wealth. I think the Barron's piece is correct in its assumption that the time is now for these cash rich corporations to start to return more to investors. As this happens money will pour into this market from investors who are in desperate need of income and without other alternatives. I expect dividends to rise for the SPX this year but keep in mind this is just the beginning of a multi-year project.
2012 is of course a presidential election year and the rhetoric from both sides will be staggering. On the surface this might suggest that the uncertainty of who will be our next president will send our market into a tailspin. I am suggesting the opposite. For the time being it looks like the Republican Party is in a real horse race especially after Newt Gingrich's come from behind victory in South Carolina.
Regardless of which side of the aisle you support I believe the political environment will actually help the market. It is imperative that the democrats keep whatever momentum this economy enjoys going through the election year. The Fed is ready and apparently very willing to open up the flood gates if needed to float the economy. We can debate the wisdom in this approach another time but QE III is out there lurking putting a bid in for stocks.
On the other side of the aisle we have all the candidates talking about massive tax reductions and even proposing a flat tax. Investors will view this as a path to bringing home $Billions being held offshore. I expect proposals giving massive tax breaks to corporations willing to take these funds and invest back here at home.
All of the above lead to my final point that multiple expansion will be the pilot on our journey to 1500. At the end 2011 the S&P 500 traded at 13.1 x trailing earnings. Current consensus is looking for the S&P to earn just under $103 for 2012. The range is from a high of 106 at Deutche Bank to Goldman's estimate at the low end looking for just $98.
My bullish argument isn't based on soaring earnings for 2012. It will be increasingly difficult to get the type of earnings growth we enjoyed in the last couple of years because we are nearing peak margins. The path to 1500 is through multiple expansion. I believe it is quite reasonable for the S&P to trade at 15 x the low end of estimates at $100 to reach our 1500 target. Investors will be willing to pay more for modest growth, rising dividends and reduced volatility if it comes as a package.
We never make these predictions blindly and are prepared to alter course if and when conditions warrant. If you are still hiding in the bunker waiting for the sun to shine before venturing out it may be time to consider coming out of the cave for a breath of fresh air.
I am long AAPL.