No Recession on the Way The #1 cause of bear markets is a recession. In fact, the average market decline during a recession is 34%. The last one we had was much worse than that. So it's always beneficial to check the economic forecast before getting long stocks.
- Current US GDP = +3.1% in Q3. That is one of the best readings in several quarters. From this higher perch it is that much harder to knock the US economy into a recession.
- Housing is Heating Up: Economists note that typical recoveries are propelled by healthy construction numbers. Yet, that was certainly not the case the past few years. Now we see that coming into bloom, which will only bolster GDP results.
- Europe: They are already in recession and yet we still racked up a +3.1% GDP result. And signs are that they will start to emerge from their recession later in 2013. Unless they implode, then nothing to worry about here.
- China: Yes, a decelerating China is bad news for world growth. Gladly it seems that after several quarters of moderating growth, things are perking up there once again.
Stocks Are Undervalued The evidence here is overwhelming. Consider that the average stock market PE is 15. Now apply that to the $113 per share expected for the S&P 500 next year. That computes to 1695. Even if you say that those earnings projections are too high (which I agree is the case), then trimming it down to a more conservative level of $105 per share still gives us an S&P level of 1575. Now consider the landscape. The 10 year Treasury is paying a meager 1.75%. Your checking account and CDs are offering even less. Typically the earnings yield on stocks is 3% higher than the treasury rate. Meaning that stocks should be offering investors a 4.75% likely return. The earnings yield is nothing more than turning the P/E ratio on its head. So when we divide the $105 projected earnings next year by the current S&P reading of 1430, we get a 7.34% earnings yield. Even more abundant proof of the undervalued nature of stocks at this time. With all the above, I am very comfortable putting out a 2013 target of 1600 for the S&P. That is still only an earnings yield of 6.56%. So if we get towards the end of the year with GDP in healthy shape and no recession on the horizon, then we could even get a good stretch above 1600.
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