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Few Wall Street strategists stack up as well as Citigroup's Tobias Levkovich. His weekly Monday Morning Musings research report is must-read material because he takes an unbiased, statistical approach to defining probabilities for the direction of equity prices. This week's report was of particular interest and importance because I can't recall the last time he was so bullish.

Here are some items from his report that should provide the bulls with reason to be upbeat:

  • The other P/E, Citigroup's proprietary panic/euphoria gauge, has crossed into "panic" territory. This indicator takes into account margin debt, sentiment polls, gasoline prices and other data points that provide a comprehensive read on sentiment and investor behavior. More than 85% of the time that a panic reading has been seen, stocks have been higher six months out. And if you can hold on for a year, you have a 95% chance of making money.
  • Lower gasoline prices could lead to a dramatic shift in consumer sentiment. Gasoline prices have been declining lately, and equity markets have a high correlation with the direction of sentiment among consumers. The last time sentiment was this low (as measured by the University of Michigan consumer sentiment poll) was in March 2003, after which equity prices began moving higher.
  • Stocks are trading at 14-16 times 2006 estimated earnings. In the past, such a valuation range has led to an average 12-month gain of about 17% for the S&P 500.
  • According to AMG data, stock funds have experienced seven consecutive weeks of outflows. The last time this happened, April 2003, it marked a key inflection point that was followed by higher stock prices.
  • The Nasdaq short-interest ratio is more than two standard deviations from its mean and is near its highest reading since 1991.
  • How high does Levkovich think stocks can go? Two weeks ago, he laid out his 2006 target prices: 1,400 for the S&P 500 and 11,900 for the Dow -- 18% and 15.7% higher than their respective closing levels Friday.

    To participate in the upside you will have to look away from the current leadership provided by energy stocks, Levkovich believes. His downgrade of the group on Oct. 7 to underweight, while not perfectly timed with the recent pullback, was pretty timely given the group's tough going last week.

    Levkovich maintains overweight ratings on consumer discretionary stocks, financials, health care -- with an emphasis on pharmaceuticals and biotech -- and semiconductor and software stocks. In addition to energy, Levkovich recommends underweighting utilities, consumer staples, industrials, materials and telecom services.

    No system is perfect when it comes to predicting the direction of stock prices. But I find Levkovich's work -- which is focused more on the numbers and probabilities than gut feeling and undisciplined, haphazard reasoning -- to be better than most.

    I'm not a daytrader and I'm not in the business of calling arbitrary bottoms -- the timing is usually insignificant to my investment time horizon of three to 12 months. So I'm not saying this current downturn in stocks is by any means complete.

    What I'm saying is that one of the best strategist's proprietary indicators are aligned in a way that has resulted in impressive investment returns in the past. If this is any indication of future performance, patience and intestinal fortitude in the face of continued near-term volatility should prove profitable.
    William Gabrielski is a research associate at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback; click here to send him an email.

    Interested in more writings from William Gabrielski? Check out Stocks Under $10. For more information, click here.

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