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32 Reasons Stocks Will Jump This Year

Among the surprises: Emerging markets will cease to be the diversion they've been.

This column was originally published on Street Insight on Jan. 30 at 8:40 a.m. ET. It's being republished as a bonus for and readers. For more information about subscribing to Street Insight, please click here.

Last year around this time, I speculated on the 20 reasons U.S. stocks would rise a total of 15% for the year. This year, I have 32 reasons for a 17% total return in the

S&P 500

for the year. I believe:

1. U.S. GDP growth will average 3.0% this year. My reasons: Housing- and auto-related weakness will subside, and the GDP deflator will subtract less from nominal growth as inflation continues to decelerate.

2. Americans' median household net worth will hit another all-time high. This will be due to home values remaining near record highs after a historic run-up, stock portfolios continuing to rise, wages continuing to outpace inflation and unemployment remaining low.

3. Consumer spending will accelerate back to above-average rates. The catalysts include more seasonally appropriate weather, a healthy job market, wages substantially outpacing inflation, rising stocks, a stabilizing housing market, pent-up demand, lower energy prices and rising confidence.

4. Housing sales are likely to improve modestly. This will lead to a dramatic decline in home inventories as new construction remains muted throughout the year. The average home price is likely to trend slightly lower through the first two quarters of the year, before a modest uptick into year-end leaves prices about even.

5. The unemployment rate will average 4.5% throughout the year. It has averaged a very low 4.6% over the last 12 months and has been lower than that during only two other periods since the mid-1950s. More technology, health care and financial jobs will help offset real estate-related job losses.

6. Americans' average hourly earnings will continue to rise well above the rate of inflation as measured by the consumer price index. U.S. AHE rose 4.2% year over year in December, substantially above the 3.2% year-over-year average for the last 20 years. Throughout the 1990s' economic expansion, AHE exceeded current annual rates of 4.2% during only four months.

7. Measures of inflation will continue to decelerate throughout most of the year, as commodities decline and global growth decelerates from current levels, with CPI averaging around 2.0%. This would be meaningfully below the 20-year average annual rise in CPI of 3.1%. The CPI rose 1.3%, 2.0% and 2.5% year over year during the last three months of the year. The CPI has been lower than current rates during only four other periods since the mid-1960s.

8. Consumers' irrational pessimism will lift. I'll go so far as to say that both main gauges -- the Conference Board's measure and the University of Michigan's Consumer Sentiment Survey -- of their sentiment will make new cycle highs, moving to levels normally associated with healthy economic expansions. While overall U.S. public sentiment is still depressed given the macro backdrop, I see some signs that pessimism is lifting a bit (anecdotal evidence and subindices of the confidence readings). This should make the many bears very nervous, because keeping the public excessively pessimistic on U.S. stocks has been one of their main weapons.

9. The 10-year yield will average 4.75% for the year as economic growth comes in around average levels, inflation decelerates further, the U.S. dollar remains stable to higher and international investors' demand for U.S. Treasuries remains strong.

10. The

Federal Reserve

will leave the fed funds target rate at 5.25% while making both hawkish and dovish comments throughout the year, depending on current market perceptions. I don't believe a move is coming, but I do believe a cut is more likely than a hike.

11. The U.S. dollar index will remain stable to higher. I see it trading in a range of 80.0 to 93.0 as the U.S. budget deficit continues to improve, U.S. economic growth improves relative to global economic growth, cracks in the euro develop and international demand for U.S. assets rises.

12. The U.S. budget deficit, which is currently 1.5% of GDP, well below the 40-year average of 2.3% of GDP, will continue to trend lower as healthy economic activity continues to boost tax receipts substantially more than estimates.

13. Corporate spending will rise more than expected. Companies flush with cash will gain confidence in the sustainability of the current expansion and spend on productivity-enhancing technologies.

14. S&P 500 earnings will rise about 8.0% for the year, still slightly above the long-term average of 7%. The most-cyclical companies will see a meaningful deceleration in growth, which will more than offset acceleration in other areas.

15. The mania for commodities will completely end. We'll even recognize a bear market in the sector as the CRB Index falls another 10% to 15% for the year. The end of the commodity mania will be viewed as the "pin that pricked the U.S. negativity bubble."

16. Oil falls to $35 to $40 per barrel as the extreme euphoria surrounding its push above $70 per barrel last year finally gets viewed as a major top. Among the catalysts I see for this outcome:

  • lower growth in the demand for oil in emerging-market economies
  • an explosion in alternatives
  • rising spare production capacity
  • increasing global refining capacity
  • the complete debunking of the hugely flawed "peak oil" theory
  • a firmer U.S. dollar
  • less demand for gas-guzzling vehicles
  • accelerating non-OPEC production
  • a reversal of the "contango" in the futures market
  • a smaller risk premium
  • essentially full global storage
  • downside speculation by investment funds

I also expect oil to test $20 to $25 per barrel within the next three years.

17. The situation in the Middle East will "beat" very low expectations as Iran, with the government under fire due to rapidly deteriorating economic conditions, makes some concessions regarding its nuclear program and as the violence in Iraq actually lessens to some extent in the second half of the year.

18. The hugely positive effects from the meaningful decline in energy prices will continue to assert themselves throughout the U.S. economy and stock market.

19. Natural gas will break below last September's low of $4.05 per million BTU as absolute levels in storage hit an all-time high and liquefied natural gas imports into the U.S. surge over 30%.

20. Gold will break below $550 per ounce as demand continues to languish, inflation decelerates further, the U.S. dollar stabilizes and even rises, and investment-fund speculation subsides.

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21. Copper will fall below $2 per pound as demand from emerging-market economies slows, investment-fund downside speculation rises, U.S. demand remains subdued as homebuilders work down inventories, and production rises.

22. Growth in China will slow more than estimated as government policies aimed at putting the brakes on investment finally take hold and many large construction projects are completed in preparation for the 2008 Olympics.

23. Emerging stock markets will underperform developed markets as the ending of the mania for commodities slows emerging-market economies. I am keeping a close eye on the Vietnam Stock Index (VNINDEX on


), which recently has dwarfed the


meteoric rise in the late 1990s, rocketing 232.4% higher over the last 12 months. It's already 38.5% higher this year. The bursting of this bubble in Vietnam, which I suspect will begin very soon, may well signal the end of the mania for emerging-market stocks.

24. U.S. stocks will see increasing demand, specifically from the public and international investors, as the manias for commodities, emerging markets and low/negative correlation U.S. stock strategies reverse course.

25. Similar to No. 8, investors' irrational pessimism will lift. The 50-week moving average of the American Association of Individual Investors investor survey's level of bears, which is currently at very high levels seen only two other times since tracking began in the 1980s, will move back to levels normally associated with strong bull markets. After hitting new all-time records during the first half of the year, short interest on the


and Nasdaq finally will show meaningful declines in the second half of the year, as some bears finally capitulate and investment funds that benefit from a declining or stagnant U.S. stock market begin to see meaningful redemptions. The percentage of U.S. mutual fund assets in domestic stocks is at the lowest since at least 1984, when record-keeping began. U.S. stock mutual funds, which have seen outflows for almost all of the last year, finally will see meaningful inflows.

26. A low supply of U.S. stocks and increasing demand will make for a lethally bullish combination.

27. Merger and acquisition activity will remain robust. Private-equity buying power currently is projected to be around $1.5 trillion, and S&P 500 companies are flush with $609.6 billion in cash, double the amount they had in 1999.

28. The supply of U.S. stock will remain low. The total value of U.S. shares contracted in 2006, despite stocks' rising prices, by the greatest amount in 22 years as a result of booming M&A, giant corporate stock buybacks, muted IPO activity and limited secondary offerings. I expect more of the same in 2007.

29. Options backdating scandals will subside, and investors finally will begin to view U.S. stocks' balance sheets as the cleanest and most transparent in the world.

30. The belief by many that the U.S. is still in a secular bear market will completely fade as the S&P 500 breaks out to an all-time high, joining the


and Russell 2000.

31. The price-to-earnings ratio on the S&P 500 will rise to 18.1 by year-end. Despite a 92.0% total return (which is equivalent to a 16.3% average annual return) for the S&P 500 since the October 2002 bottom, its forward P/E has contracted relentlessly and now stands at a very reasonable 15.6. The 20-year average P/E for the S&P 500 is 23.0. The S&P 500's P/E multiple has contracted for three consecutive years. It has contracted for four consecutive years only twice since 1905. Each point of multiple expansion is equivalent to a 6.6% gain in the S&P 500.

32. "Growth" stocks will lead the broad market higher, with the

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rising a total of 25%. On a price-to-cash flow basis, "growth" stocks are cheaper than "value" stocks for the first time since at least 1977. Almost the entire decline in the S&P 500's P/E since the bubble burst in 2000 can be attributed to multiple contraction in growth stocks. Technology, telecom, retail, biotech, medical, health care, investment banking, restaurant, gaming and airline shares are likely to be the top performers.

At the time of publication, Smith had no positions in any of the stocks mentioned in this column, although holdings can change at any time.

Gary Douglas Smith actively trades his portfolio as well as the portfolios of family members. In addition, Mr. Smith maintains

Between the Hedges

, an investment-oriented blog. Previously, he was founder and managing member of Olympus Capital Management, an alternative investment firm. Olympus consisted of a long/short diversified hedge fund and a long/short technology sector hedge fund. Prior to the formation of Olympus, he spent five years as Vice-President of Research and Portfolio Manager for an independent money management firm. Mr. Smith has been engaged for the past 23 years in the analysis and selection of equity and other investments. His expertise is in long/short U.S. equity investing across all market sectors with an emphasis on technology stocks. He uses a top-down investment approach, investing is securities at a reasonable price relative to their growth prospects. As well, technical analysis plays a role in the timing of his investment decisions. He received his undergraduate degree from the University of Tennessee and subsequently received an MBA, with a concentration in finance, from Vanderbilt University's Owen School. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While Smith cannot provide investment advice or recommendations, he appreciates your feedback;

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