Although 2012 was a strong year for the S&P 500 — it was up 13% — these gains weren’t enough to get the market back to where it should be. The stock market continues to be undervalued by approximately 20%. My analysis points to significant gains ahead for the stock market in 2013 and beyond.
Ten Year Chart
To the right is a ten-year chart of the S&P 500. There are two things that stand out in this chart. First, at the bottom you can see S&P 500 profits are set to climb 5% in 2012 (once the numbers are crunched). That’s deceleration from the 15% growth we saw in 2011. Normally, deceleration isn’t a good thing and leads to markets cooling.
Second, note the Yearly Profit Growth for the S&P was 8% during the past decade, yet the S&P 500 Index, Yearly Index Growth, was only 5%. Typically profit growth = stock growth (or in this case index growth) when we look at decade long views. The stock market has some catching up to do, and since the market is so cheap, it should continue to rise to “get to where it should be” even in the face of decelerating profit growth.
Fair Value
On the right is a table of the S&P 500’s price and profit history. I want to focus on the P/E ratio of the market. Notice for much of the decade the market’s P/E (S&P 500) was around 17. The P/E for the past two years had been abnormally low. I feel this is due to European upheavals and crisis’ as well as political issues here in the states. Now we are entering 2013 and most of these issues are behind us. The lack of bad news should take pressure off the market and alow it to get to where it should be.
The stock market should be selling for 18 times earnings. Historically, during times of low interest rates, stocks are typically more valuable than bonds. Thus 18 times earnings is where the market should be. This 18 P/E is what Wharton Professor Jeremy Siegel also things the market should be selling for. I think if rates were higher (more normal) a 16 P/E would be fair.
Right now the market is selling for 14 times earnings. Notice in the Fair Value table that’s abnormally low. For me to say the P/E should rise to 18 this year is asking too much. That would equate to around a 36% stock market gain in 2013. Instead I feel the market will go on a multi-year climb where the market posts double-digit annual returns.
Other smart money managers — such as Ron Barron and Laszlo Birinyi — feel we are in the midst of a multi-year bull run. Birinyi was recently quoted as saying “Our view all along since 2009 is that we’re in the midst of a protracted bull market, similar to 1982 and 1992, markets that went on for four or five years.”
Sharek’s Take
History repeats itself in the stock market. Using stock market history as a guide, my analysis of the current market fundamentals points to a 21% rise in the stock market for 2013 and a total gain of 46% between now and the end of 2014. Even if we don’t “get to where we should be”, we will still be in an undervalued market that possesses solid upside for the future. I see one of two scenarios playing out: either a spike in the market the next two years or a solid three-to-five year Bull Market run with consistent double-digit annual returns like we saw in the early-to-mid 1980s.
The stock market’s cheap, and has solid upside. This is a good time to be in stocks.
