The IMF on Tuesday released its forecast for economic growth in 2012. It expects the world economies to grow by 3.3% and the U.S. at the same 1.8% as we did in 2011. These predictions are subject to constant revision but if the IMF is correct and the historical ratio of S&P 500 earnings growth equaling 4 time GDP holds, the 1.8% figure equates to S&P earnings of $106, up from the $99 in 2011. The long term average S&P Price to Earnings ratio is about 15.8 times and if achieved would put the S&P at 1675. To compound matters, historical market volatility averages 20% per year and applying that figure to the 1257.60 close in 2011 we can expect a range of 1000 to 1500. This all presumes no major economic upheavals or unexpected surprises.
Among the known risks we see for the year are:
· Iran currency collapse leading to a mid-east war
· U.S Budget deficits and debt issues
· European bank defaults causing
· World-wide recession
· China hard landing
The positives could include:
· Real Estate prices bottoming
· Euro chaos leading to a strong dollar & equity prices
· Decreasing unemployment
· Lower oil prices
· Congress & the President agreeing to a budget & fiscal restraint
· China soft-landing
While we don't see inflation as a 2012 issue, it could occur unexpectedly due to any number of confidence crushing events or a combination thereof causing a bond sell off that forces rates up. A run on the dollar could push oil & commodity prices up and dramatically increase the deficit as well as destroy any positive economic conditions. This could then lead to a major downturn in stock prices. Lows in the past century were always at P/E ratios under 10 times earnings. The lows of 1919-21, 1932-34, 1938, 1942, 1949, 1974 & 1982 all occurred between a 4.78 & 10 P/E. If we assume this happens here at 7.5X, we see the risk down to 800 on the S&P 500.
Given this range of possibilities, we prefer to allow stock prices & momentum to give us a better sense of direction. Like a GPS device can pinpoint where you are and tell you how to get where you want to go, QPM Radar™ provides a clearer roadmap for the investment portfolio decisions we have to make on behalf of our clients. We use standard valuation techniques to arrive at what we want to invest in but we also patiently wait for our technical system to determine when we act on them.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.