Herb Morgan (Efficient Market Advisors, LLC) submits: With each passing day I become more convinced of the coming rally in stock prices. I believe the upside potential in the S&P 500 to be close to 35% over the next thirteen months provided interest rates remain at current levels. Returns should be only slightly lower if interest rates rise modestly. I look to the Fed Model to support my assertion:
The above chart assumes that the ten year treasury moves from its current level of 4.47% to 5.0% by the end of 2006. It also assumes that the current consensus estimates for S&P500 earnings are accurate. One could easily make the case that consensus estimates are low for the following reasons:
- Companies are increasingly buying back stock which is near impossible for analysts to predict.
- Looking at reported earnings for Q3 2005 shows a high percentage of upside surprises indicating that forward estimates may also be low.
- Analysts are, on the margin; more honest in their estimates today than they were pre-scandals. (While I believe there is still plenty of sneakiness in the analyst community, I believe the percentage of analysts that are investment banking shills is much lower than it was in recent years.)
- With the exception of a few .com names the market lacks any frothiness or excess.
- Interest rates won’t go through the roof any time soon, unless Mr. Bernanke suddenly becomes a Keynesian.
- Lower taxes on dividends and capital gains have yet to fully manifest themselves in equity prices.
- The trend towards increasing dividends should continue and will help support stock prices in the face of modestly higher interest rates.
Given the large volume of individual stocks in the market today makes it difficult for the average investor to be confident in their ability to capture the gains of the broad market. For this reason, investors may consider ETFs with broad market exposure, such as SPY, IVV, IYY, IWV and VTI.
Investors may tactically overweight equities to take advantage of this viewpoint.
Herb Morgan is President and Chief Investment Officer of Efficient Market Advisors, LLC a private money management firm in San Diego California which specializes in managed accounts of Exchange Traded Funds. www.etfmanager.com.