Forecast: Top 4 Reasons the Markets Could Continue to Rally in 2013
Investors in cash are getting a negative return after inflation, making equities look more attractive. Despite some dissension in the Federal Reserve ranks, Fed Chairman Ben Bernanke has pledged to hold the federal funds rate near zero as long as inflation doesn't top 2.5% and unemployment remains above 6.5%, reassuring investors that the party won't stop anytime soon.
3. The housing sector has been a bright spot. The housing sector is still acting as a tailwind for the overall economy. Sales of new houses are up to 2008 levels and existing housing stock is shrinking, feeding the trend. The manufacturing sector is showing improvement across industries and new orders were up in February for the second month in a row.
4. Price-to-Earnings ratios are still relatively low with respect to historic values. PE ratios are one of the ways we evaluate whether a stock is overvalued. The chart below shows historic PE ratios using reported earnings for the trailing 12-month period (TTM) of the S&P 500 from 1900 to today. The PE ratio on March 11 (calculated using the last official EPS data from 2012) was just shy of 18, only a couple of points above the historical mean of 15.49.
The S&P data are lagging and we still don't have official numbers for Q4 of 2012. However, the unofficial estimates released by Standard & Poor's show an EPS of $87.93 for Q4, and a forward-looking estimate of $89.63 for Q1 2013, well above the Q3 EPS of $86.50. Some analysts might argue that equities are overvalued in any period during which the PE is above the long-term average, favoring mean reversion over future expectations. We beleive that this is a short-sighted view. When earnings appear to be increasing, profits are up as companies have adapted to doing more with less, and business confidence is back. In the short term, the market may back off of these highs, but where some analysts see froth and exuberance, we see priced-in expectations and solid fundamentals. While there continue to be risks to the markets, we're with the bulls in 2013. At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time. This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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