Tone Turns Bullish at Brokerages - TheStreet

The recent swoon in the U.S. stock market has left the major averages undervalued and poised to rally, according to three Wall Street brokerages Monday.

Stocks have been in free fall over the past few weeks, pushing the

Nasdaq

to its lowest point since early October and the broader market to levels not seen since September. But analysts believe an end to the bloodletting may be in sight, at least for the short term.

"Despite our continuing downbeat view of the economy, valuations in the market have improved and investor sentiment has become more cautious," said Banc of America strategist and long-time bear Tom McManus.

McManus raised his recommended stock allocation to 55% from 50% Monday, saying he expects a rally to develop that will push the popular averages "a few percent higher."

Still, he cautioned that the economy would likely "sputter" for the balance of the year and said aggressive Fed rate hikes could derail the recovery later on.

Meanwhile, Salomon Smith Barney analyst Tobias Levkovich said he is looking for stocks to climb 20% or more from the current depths, saying while valuations are still high historically, inflation remains below historical levels "and thus the real value of assets should be worth more."

"It looks like another leg of the recovery story is coming into place," he said in a research note. "Valuations seem to be in line with previous bottoms."

Despite that, Levkovich slashed his year-end targets on the

Dow

and

S&P 500

, saying he can no longer envision the market rebounding to 1300 or more within the next six months, given the recent lows and technical breakdown.

He trimmed his target on the S&P 500 to between 1200 and 1250, from 1300 to 1350, and reduced his estimate on the Dow to 11,200 from 11,400. In order to achieve those new targets, the Dow and S&P would have to rise at least 16.5% from current levels.

Goldman Sachs analyst and long-time bull Abby Joseph Cohen also had some encouraging words for investors Monday, saying corporate data suggest that the "basics are sound." In fact, Cohen believes the Dow and S&P 500 are undervalued by more than 17% and 20%, respectively.

Thus far in the second quarter, negative preannouncements are only slightly more common than positive announcements, resulting in a ratio of 1:2. "This is the lowest ever, and may suggest that earnings expectations have hit bottom," she said.

Turning to the recent weakness in the dollar, Cohen said an "orderly" decline may benefit U.S. cyclical growth and allow other countries to make important structural changes. A weaker currency is typically viewed as a positive, encouraging exports and stronger profits, she said. But in the case of the dollar, the extended period of strength allowed other nations to focus on export-led recoveries rather than economic reform and improving domestic demand.

Despite the overall bullishness Monday, Merrill Lynch quantitative analyst Richard Bernstein isn't convinced that a long-term durable market bottom is in place.

Refuting analysts' claims that the market is cheap, Bernstein said the P/E to growth ratio on the S&P 500 is "about the highest in the 20-year history of our data" and that the "plain vanilla" P/E ratio is the highest in history.

Bernstein noted that lofty valuations typically spur equity issuance, which in turn places a ceiling on market rallies. In addition, he said investors are overly optimistic about a recovery in corporate profits, noting that S&P 500 earnings are the least predictable in about 55 years.

Although the S&P 500 is down more than 12% from its peak in January and the Nasdaq is down 26% from its highest point, "valuation, earnings risk and the continued opaqueness of company reporting suggest that considerable risks remain within the equity market," he said.