Just last month we were spooked by a 400-point one-day drop in the Dow after a huge sell-off in the China market. Chinese stocks rebounded to make new highs and now the U.S. market has done the same. The 2006 correction was very similar, short and swift. In fact, compare the two charts:
Bears will undoubtedly be looking for a failed breakout and another leg down. Despite the fact that the market has been pricing in an interest rate cut, and yet no rate cut seems imminent, stock prices keep chugging along. I am in the camp that believes the Fed is on hold and won't cut rates due to a perceived credit crunch. Things would have to get meaningfully worse on that front for Bernanke to move, in my opinion.
Where does that leave stocks? I am still standing by my mid-to-high single digit return prediction for the U.S. market in 2007. Currently, the S&P 500 is up 3.5% year-to-date. I just can't get overly bullish with decelerating profits and a Fed that is still concerned with inflation. What would be the catalyst for a big move up? Earnings would have to really be strong. I'm not expecting a huge downward revision to current estimates, but this economy doesn't seem to me to have much upside right now.
With what we know now, the market seems pretty fairly valued overall. I think we'll trade between 14 and 16 times earnings in this environment. I think the strategists calling for P/E expansion are dreaming. Sure, employment is high and interest rates and inflation are relatively low, but we still have single digit earnings growth and a slightly above-average valuation on the market. Hardly reason to be overly bullish.
In times like these, I'd suggest investing in cheap companies rather than a fairly valued market.