The stock market is so cheap that a big move could come just after the European crisis ends.
The stock market is set to break out higher
To the right is a one-year chart of the S&P 500. What I like about this chart is:
- The market fell during the summer yet did not break down. After the first fall during the week of August 12th, smart money felt the market would have to fall again and dip below those lows before we could move forward. Yes, this went on to happen, as the S&P went down even lower the week of October 7th. Mission accomplished.
- Now the S&P has built a cup and handle (this chart was completed last month, and since then the market has moved sideways). The stock market is giving us a perfect rally point — 1285. That was the recent high. If we move above this the market could go on a roll higher.
- The market’s P/E is only 13. Although growth has slowed during the year, profit growth is still over 10% which is good for the entire market. Yes, growth has slowed from the 30% range, but that was unsustainable.
Stock growth hasn’t kept up with profit growth
The ten-year chart (right) also looks solid. Here’s what I like about this chart:
- The profit growth for the S&P has been 10% a year during the decade, yet stocks have climbed only 1% a year. These two figures should be similar, and since the profit numbers are almost in the books, the market has some catching up to do.
- 2011 will be a new high for profits (this is along the right of the chart). The S&P could make $97 this year, WAY higher than the previous record of $88 set in 2006. Seriously. Everybody is scared of the market this year yet the market is telling investors everything is good.
- If profits are at a record high then the market should be too. As of today the S&P stands at 1252. The high set in October 2007 is 1549. The market has to rise 24% just to get to the old high — which at this point doesn’t look that high at all.
The market hasn’t been this cheap since 1998
Now let’s look at the S&P’s P/E. This table shows the P/E of the S&P at year end, since 1998. In the P/E column, I shaded a cheap market in green, and expensive one in red.
Not only is the market’s P/E cheap right now — this is the cheapest market we’ve seen since 1998!
Taking a guess as to where the P/E should be, recent history shows 16-18 is fair. 16 times this year’s earnings estimates nets a S&P 500 of 1546 — 23% higher than today. That’s this year’s estimate.
Bottom Line
The bottom line is with the market setting up to breakout and a market selling 23-24% below where it should be. Its the middle of November and the move could happen by the end of the year. We could be in for a solid Santa Clause rally. Merry Christmas!
