By Thomas and Robert Fross, Co-foundersNEW YORK ( Fross & Fross Wealth Management) -- With equities at or near new highs in the first quarter, plenty of analysts say that the markets will run out of steam, as they did in 2011 and 2012. However, we think that the situation is fundamentally different in 2013 and that the markets still have room to run. Despite some major headwinds from sequestration and the deteriorating situation in Europe, U.S. markets have put up an impressive performance in the first quarter, fueled by liquidity and upbeat economic reports. Earlier this month, the Dow Jones Industrial Average cracked 14,400, while the S&P 500 approached its record close. While you cannot invest directly in an index, and their recent performance does not guarantee their future returns, we are encouraged by this recent action. Many analysts fear that the rally won't last and that we'll see a repeat of the disappointing mid-year performance of 2011 and 2012. In the short term, we agree that equities may be overbought and investors should expect a little consolidation, but we think there's plenty of room for optimism about the market rally this year.
Here's why: 1. This is one of the most unbelieved rallies we've ever seen, and it has hung in there despite the odds. Retail investors remain skeptical and we think that there's a lot of money sitting on the sidelines. A look at the Investment Company Institute's statistics on money market accounts tells us that there is still a lot of cash parked in institutional and retail money market accounts that could be injected into equities.
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.