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Article on why the SPX is going to 1300.....
by Kevin Cook

Link: https://mail.google.com/mail/?shva=1#compose


7 reasons the S&P 500 is going to 1,300

Why this bull train you can still catch has 10% more upside

* Headshot of Kevin Cook Kevin Cook is an options instructor for the Options News Network. He was an institutional foreign exchange market maker and arbitrageur for nine years, where he worked with futures.

by Kevin Cook March 24, 2010 12:45 EDT Related Symbols: CAT, DXY, SPX, VIX, XRT


In Steven Johnson’s 2004 book about remarkable brain science research, Mind Wide Open, I latched onto a key phrase he used to describe important secular themes in science and culture. “Long-decay ideas transform as much as they inform,” he said. By “long-decay,” he meant ideas that stand the test of time.

In investing, there could be lots of rules that guide you for decades. I’m not going to talk about those today, mostly because I’m not qualified to advise on diversification or dividend re-investing or dollar-cost averaging. But in the short-term of economic cycle swings, I think there are certain simple ideas you can focus on and do better than those who try to outsmart the market.

Did you notice how well the market shook off the sovereign debt worries of the last three months? If you had listened exclusively to PIMCO’s Mohamed El-Erian about the coming dominating theme for financial markets—sovereign balance sheets—you would have probably been thinking about how soon and to what degree you should move out of equities and into cash.

The January sell-off was quickly and decisively lost by the bears who had probably been hoping for much more downside than 9% — a “correction” barely worthy of the title. The two-year chart below of the S&P 500 shows the areas the market is gunning for now, with significant resistance likely at 1,200, the site of the Lehman “credit crisis cliff,” from which the market fell more than 25% in two weeks.

Weekly chart of SPX since March 2008

Why the S&P Can Go to 1,300

1) We’ve Seen Sovereign Default Risk and We’re Not Afraid

As discussed, the market shook it off like a wet dog sheds water. And it has priced in the woes of all those little PIIGS next in line—be it Spain, Italy, Ireland, or Portugal, which just received its downgrade this morning from Fitch. I’m not saying that El-Erian isn’t correct; he probably is very prescient about the next few years. I’m just saying the market isn’t very worried about it now and this is clearly evident from its eight-week, 130-point, 12% rally to yesterday’s new 18-month high of 1,174.

This puts in perspective a long-decay idea I’ve been talking about for a year now: the threat of the U.S. losing its triple-A credit rating due to our rising debt and debasement of the currency. I’ve said repeatedly that it almost doesn’t matter, because in the midst of a bunch of bad apples, the U.S. is still the biggest and best pie in town. I wrote The Decline and Fall of the U.S. Dollar for MarketWatch.com in October when there was much hand-wringing about such matters and the dollar index was approaching its all-time lows near 70.

Since then, my piece 2 Dynamics of Dollar Strength: Rates and Debt explained where we are now with the dollar index (DXY) above 80. And Euro Headed Lower Still from February 16th has a chart with my argument of why you could comfortably sell the euro on any rallies to $1.38. This morning, it has slipped to 10-month lows below $1.3350.

2) $75 EPS = 17 P/E Multiple

Consensus EPS estimates for the S&P 500 are near $75. Between 1,250 and 1,300, this is a reasonable price-to-earnings (P/E) multiple of 17 when the economy is still in the early innings of a cyclical recovery. Estimates for 2011 will probably be higher. That’s the “V-recovery spread” I talked about for most of 2009 whereby equity portfolio managers will continue to buy stocks in aggregate whose earnings are recovering faster than their P/Es rise, especially with no sign of a double-dip recession and housing markets bottoming. For the view from 4Q09, see my S&P 500 Valuation—What’s the Over/Under?

3) The Bull Train You Can’t Short

From my November 4th article about The Bull Train You Can’t Catch: The “unstoppable force” I talked about in August and September is still in play. Fund managers are buying the V-Recovery in earnings and the economy and they can’t be left behind. Even if economic stats indicate it’s not a “V,” they will still buy and err on the side of being long as earnings recovery makes upside surprises their greatest risk. There are trillions of dollars all chasing the same metric of “meet or beat the S&P.”

Well, in the last four months, the “bull train you can’t catch” actually slowed down so much it almost stopped. But it still defies the bears who just can’t get a leg over on it. To highlight a few points by Barton Biggs this week from a Bloomberg-TV interview:

* People are underinvested
* They are surprised by the market’s strength
* Left behind, they feel pressure to perform and will chase the rallies

Readers of this column know that this is what I’ve been saying since last July: the wall of doubt gives as much propulsion to a reluctant bull market as any wall of worry. And it’s still true now.

4) Emerging Markets Continue to Lead the Charge

The threat of a China slowdown, merely because they have to tighten interest rates to prevent overheating, is a small matter relative to the macro-secular growth trends occurring in most emerging markets. Several hundred million citizens in emerging Asia, South America, and Africa are pursuing better jobs, housing, transportation, and food. This is driving their economies and their governments to support full-tilt growth strategies. I summed up some of these ideas in my recent piece Emerging Markets Drive Global Recovery: CAT and ETN.

5) 1,100 Will Be Major Support

First, the S&P 500 spent nearly four months gravitating around the 1,100 mark. That’s why the CBOE Market Volatility Index (VIX) is stuck below 20—volatility slowly collapsed as the market went into slow motion. When we do get a fear spike and volatility-driven sell-off—which will likely happen before we get to S&P 1,250—that 1,100 mark will be seen as a safe and attractive buying level where institutional investors spent a lot of time evaluating, accumulating, and ultimately regretting they didn’t buy more shares. That means buyers will come in before 1,100. The second support factor near 1,100 will be the 10- and 20-week moving averages, currently hanging out together around 1,113. Many technically-oriented funds will be buyers there. Which, again, means it won’t even get that low.

If it sounds as though I am crafting this argument with 20/20 hindsight, see how I predicted it exactly for the January correction, calling the first bounce above S&P 1,040 in the first week of February: S&P 500 Correction: How Low Can It Go? I was too cautious about how quickly the market would recover in the following seven weeks, thinking that we would finally get a correction bigger than June-July’s 9%. But I felt strongly that large investors would support the market above 1,025 for reasons 1-4, and that has happened convincingly, giving us reason #5 to remain bullish.

6) Fed Constancy—You Can Bank On It

We are still in the sweet spot for economic recovery and growth with nearly-certain knowledge that the Fed will be on hold—for the next two quarters at least—to support the “full employment” half of their mandate. With less inflation in sight than they really want to see, it’s full steam ahead for the economy.

Also of note this morning is rising Fed star Janet Yellen’s observation that housing’s weakness will keep the Fed on hold for longer than most think. I have written extensively about this as well and most recently in January’s Bernanke’s Eye on Real Estate.

So, if I think that housing is bottoming, yet the Fed is still worried about it, what is it they are right about? They are concerned with a web of economic effects revolving around foreclosures, unemployment, and consumer sentiment. These forces affect the health of an economic recovery, or lack of one, as much as any. They certainly know more than I do about the details of the economy, but the housing data in aggregate seem to have a bottoming process in motion. A slow grind lower doesn’t seem likely to me, and this is supported by my last reason to be bullish.

7) Consumer is Alive and Kicking

This one caught me by surprise late last year. In October, I was certain that retail stocks were overpriced and I said to avoid them in favor of sectors and groups that were not dependent on the consumer: industrials and materials, infrastructure plays, biotech, emerging markets, agriculture, and enterprise technology. But staying with retail has been a winning bet, as is evident from the chart below comparing the relative performance of the Select Sector SPDR Retail ETF (XRT) to the S&P 500, up 82% vs. 42%, respectively, for the past year.

Daily Chart of SPX and XRT

Retail stocks have been outperforming the broad averages because the alleged death of the American consumer was premature. Government retail sales figures have surprised month after month, as well as company earnings from stores themselves quarter after quarter. If this is how bad it gets during the worst housing meltdown, foreclosure crisis, and highest unemployment in decades, it leaves me asking how much upside is possible as these problems self-repair.

I look forward to looking back at these themes in nine months to see if any maintained some “long decay idea” status. Simply “following trends” in the economy and in markets is probably the single overriding long-decay idea here. There’s no need to be smarter than the market when you can just put together a few trends that tell you which way the wind is blowing.

For a “longer-term” long-decay trend, see my series of articles on biotech, with the most recent yesterday’s Biotech wins big with Obamacare: IBB and FBT.