This means the S&P 500 trades at around 11.4 times projected 2012 profits. Stocks, on average, have traded for 15.9 times forward earnings during the past 30 years. The fact that interest rates are extremely low argues for an even higher multiple. So if the economy can get past the current rocky phase and start to grow at a steadier and more moderate pace, then look for many market strategists to cite that low P/E ratio as a case for market upside.
Is such a benign economic view justified? Well, recent data points imply the U.S. economy may be on the mend. The economy expanded just 0.4% in the first quarter of 2011, another 1.3% in the second quarter, 2% in the third quarter, and consensus forecasts call for 3% year-over-growth in the fourth quarter. A few Wall Street firms are even predicting a fourth-quarter growth rate above 3.5%. With the exception of a big snapback in the first quarter of 2010, this would be the strongest quarterly showing in nearly five years. Still, don't expect this kind of growth throughout 2012. There are just too many headwinds in place. Nevertheless, anything above 2% would be very welcomed by investors.
To keep growing at a 2% or 3% clip in 2012 will require that Europe and China don't slump badly. Europe is already experiencing a modest recession, and fingers are crossed that things don't spiral lower from here. So there is a case for cautious optimism for the U.S. economy -- and stocks -- in 2012.Equally important, remember that "investors look ahead." So even as we'll see real challenges in 2012, the market may actually trade off of 2013 expectations. Goldman Sachs expects the world economy to expand 4.1% in 2013, a full percentage point higher than projected 2012 growth. Of course, sector selection will be paramount. The S&P 500 may post gains in 2012, but some sectors will lag while others really thrive. Let's look at the technology sector as an example. It may be unwise to own a fund focused on the whole sector, as the outlook for subsectors varies. For example, consumer-focused tech stocks, especially those tied to PCs, may see another tough year in 2012. In contrast, companies in the chip-equipment sector have badly lagged in recent years and may be on the cusp of the next spending cycle upgrade. Names that hold appeal include Applied Materials (AMAT - Get Report) and GT Advanced Technologies (GTAT), both of which trade for less than eight times projected earnings.