4 Reasons Stocks Are Ready to Hit New Highs

by: Steve Reitmeister
In the summer of 2010, investors became obsessed with the idea of a double dip recession. With that the market pressed down to Dow 10,000 with many experts looking for a lot more losses to come. From that darkest hour we have emerged with an impressive 20%+ rally lasting over six months.

Now the question on everyone’s mind is; What’s next for the stock market?

I strongly believe the answer is that we are due for more gains. Not just because there is no double dip. More importantly, there are sound fundamental reasons for the market to continue its advance. 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 Q4 earnings season, you ask?: Here are the results for the S&P 500 (NYSEARCA:SPY) stocks.
  • 3.42 stocks had a positive surprise for every 1 that was negative
  • 1.88 positive estimate revisions ratio. Meaning estimates are moving up for the future.
  • Year over year growth of +43.7%
2) Valuation
Thanks to the strong earnings noted above, the bottoms up estimates for the S&P 500 next year currently stands at $96.04. Which means that the S&P is only trading at PE of 13.9 current estimates. That is very reasonable by historical standards.
Now consider the earnings yield of stocks, which is dividing the $96.04 in earnings by the current S&P price level. That comes out to 7.2% which is VERY attractive compared with the meager 3.6% 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.
Lastly, you need to remember that we have enjoyed a string of several quarters in a row where Corporate America had sparkling earnings which lead to higher estimates. So it is quite likely that by the end of the 2011 the actual earnings may be more like $100+ instead of the current view of $96 and thus the market will rise that much more to reach fair valuation.
3) End of the Bond Rally
The 30 year bond rally ended in October 2010. The initial move higher was simply a reflexive bounce from obscenely low levels induced by all the double dip fears that drove people to the safety of bond investments. But now there are much bigger reasons for rates to go higher. And that is inflation.
Back in 2002, before he was Fed chairman, Ben Bernanke said that any outcome is better than deflation. So he outlined all the ways in which the Fed can fend off deflation by creating inflation. His methods were akin to throwing trillions of dollars out of a helicopter to the people below…and since that day many still call him Helicopter Ben.
It is clear that the Fed under Bernanke’s direction will fight deflation with every ounce of their energy. The most likely outcome is inflation and we can already see signs of it in our midst (check your recent food and gas bills to see it on the rise).
Higher inflation = higher bond rates = investors losing money in bonds = more money flowing out of bonds into the stock market for attractive returns. This equation is already in play with more momentum to come.
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 last 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.
Now that the market has pushed to new highs, the media is starting to make a big deal about the stock market once again. The more this message gets out there, the more individual investors will feel they are missing out. As they pile back into stocks it will fuel the rally higher which will pull even more investors back into the market.
How high can the market get? Given the valuation scenarios I shared above we can easily make it to Dow 13,000 without being overstretched. And if the pendulum starts to swing away from fear and back to greed it could go above that level over the next 12-18 months.
What to Do Next?
On the surface I know it sounds like I am saying to just buy any stock and you will profit from this rally. Certainly the rising tide usually lifts all boats…but some boats do a lot better than others.
First, you need to focus on companies exceeding earnings expectations each quarter which leads to higher estimates from analysts. This in turn leads to higher investor interest and a higher share price.
Second, keep an eye on valuations. Yes, I noted earlier that the overall market was reasonably priced. However, each week I go looking for new stocks I am noticing that more and more are overpriced. So only select those stocks that are trading at discounts to peers.
Here are 5 Stocks that Make the Grade

1) Apple (NASDAQ:AAPL): There is simply no logical way to do a valuation model on Apple and not come out to $500+. The main case against this valuation is that some people fear Apple will succumb to the same problems that befell other mega caps like Cisco and Microsoft. I sense this is a different animal that is nowhere near their peak. That is why Apple is the largest position in my portfolio.

2) Magna International (NYSE:MGA): After the US auto industry was on the verge of annihilation it has truly reemerged like the Phoenix. As auto sales figures continue to climb it also bolsters the results of auto suppliers like MGA which has amongst the best leverage to improvements in the US auto market.
3) Raymond James (NYSE:RJF): With the stock market pressing new highs, it’s not surprising that a brokerage firm like RJF is seeing a steep rise in profits. I still see plenty of upside in these shares as the bull rally rolls on.

4) Robbins & Myers (NYSE:RBN): Industrials led the US out of the recession and show no signs of slowing. RBN is a great play on this trend plus they have exposure to the burgeoning energy market which should propel shares from here.

5) Varian Semiconductor (NASDAQ:VSEA): At this stage of the economic expansion semiconductor equipment makers do quite well. Throw in their unique position as a supplier to the growing solar panel market and you understand why shares keep rising. This party is far from over.
Closing Note: I know there are many SeekingAlpha readers who are still 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).

Disclosure: I am long AAPL, MGA, RBN, RJF, VSEA.

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