• 2013 Outlook: Why The SPX Will Be Up For A 5th Year In A Row

    by  • January 10, 2013 6:30 am • Broad Market Analysis, Quick Hits • 3 Comments

    It’s that time of year when everyone picks their top stocks and sectors, along with various targets such as where the SPX might finish, what earnings will be, what the economy will do, etc.  Of course, as traders it isn’t our job to have an opinion and blindly stick to it, that can cost you a lot of money.  It’s our job to adapt and trade what happens.  I like to say the most successful traders are chameleons.  They simply adapt in order to succeed.  None the less, here’s my attempt at predicting what could be in store for the SPX this year.

    Last year, I had an SPX target of 1,525, which would have been about a 21% jump for the year.  This came in about 100 points too high.  Still, in the end, the SPX was up 13% for the year (and closer to 16% when you include dividends), so not perfect, but not all that bad either.

    This year I’m sticking in the bullish camp, looking for a move higher of about 14% higher in the SPX – with a year-end target of 1,650.

    There are three tenets to our methodology here at Schaeffer’s:  fundamentals, technicals, and sentiment.  We call this combination Expectational Analysis and I’ll take a look at each leg to see what they are telling us as we move into ’13.

     

    Fundamentals

    First off, do fundamentals matter?  Of course they do, but it is all relative.  Last year at this time, Greece was going to go under and it was going to take the rest of Europe with it.  A funny thing happened, the Greek stock market gained 33 percent, making it the top performer in Europe.  This happened because all of the end of the world scenarios didn’t pan out.  Heck, Germany had a GDP that barely was positive, yet their market gained 29 percent.  Again, this happened because they did better than the very low expectations.  A popular saying around here is you ‘buy low expectations, not low priced stocks’.

    I’ve said for a long time that the credit markets are a much better indicator of future economic growth then GDP, earnings, inflation, etc.  We all learned this back in ’08, when the credit markets stopped working and the market soon collapsed.  Then things started to get better in ’09, while most were expecting another shoe to drop.

    Currently, share buybacks are steadily improving (up more than double in ’11 and ’12 when compared with ’09 and ’10), M&A activity continues to show a strong pulse, and junk bonds keep making new highs.  Remember, junk bonds tend to act like stocks, and when investors are comfortable with the economy, they are willing to buy the riskiest of bonds. Why would you buy risky bonds if you think the company paying would just default? With that said, various junk bonds breaking out to new highs. I’ve read lots of talk that junk bonds are in a bubble, this could be, but we’ve also been hearing that for well over a year.  Purely from a technical point of view, nothing wrong with this picture.

    I’m not a big valuations guy, but if you compare stocks to bonds you’ll find stocks are very undervalued when measuring their ability to generate income.  Using the SPX dividend yield and comparing it to the 10-year treasury yield, the last time stocks were this cheap compared to bonds was early ’09 – not a bad time to be buying stocks.  You see, the SPX nearly always produces lower income when compared with bonds, but that that isn’t the case now. Again, the last time we saw this happen was during the midst of a generational buying opportunity in stocks.

    Lastly, earnings over the long run do drive stock prices, no doubt there.  What is my take on earnings?  I’ll resort to an awesome graph from Jim Paulsen of Wells Capital Management.  He shows that previous surges in earnings during a flat a market (like we’ve seen the past 12 years), eventually lead to higher equity prices, as overall confidence eventually improves.  Think about it this way, earnings have doubled the past 12 years and the market has gone nowhere.  The next step is confidence slowly begins to come back and people are willing to pay a higher multiple to own stocks here.  Only a matter of time.

     

    Technicals

    There are a few ways to look at the market here based on technicals and nearly all of them look bullish to me.  First off, small caps have broken out to a new all-time highs.  Given small caps tend to lead big caps, this bodes well for potential new highs in the blue chips sometime this year.  In fact, we would continue to be overweight small caps here, as this breakout could be the start of strong outperformance.

    Also, we’ve been watching the 1,000 level on the MidCap 400 for a while now.  This area was firm resistance numerous times starting clear back in April ’11.  Now this area has given way and this index is making a new high as well.  A nice looking break out.

    Turning to the SPX, it has formed a huge double top over the past 12 years.  The obvious question is can it finally break out above this area and surge to new highs?  Given the action in small and midcaps, my answer is yes – it is a matter of time and this will probably happen this year.  Also, we’re big fans of the SPX and its 80-week MA.  As you can see, this trendline has been very significant in both bull and bear markets going back 20 years.  This trendline is still firmly pointing higher and looks bullish to me.

     

     

    Sentiment

    This is the final deciding factor in my overall bullish thesis.  The reality is after some very impressive gains the past four years, the majority of investors simply don’t believe in this market for various reasons and that right there can be extremely bullish from a contrarian point of view.

    In fact, a recent Gallup poll shows just 53% of Americans owned stocks currently.  This was 65% back in ’07 and the current 53% is the lowest ratio since the poll started back in ’98.  Not to be outdone, a recent survey by the ICI found that the % of households that own mutual funds has dropped every year since ’08 to its current level of just 46% of households.

    Just last night in my car I heard on the radio a local Cincinnati investment manager talking about how most stocks are up near five year highs, explaining it like he had some big secret.

    Franklin Templeton had a recent survey of 1,000 investors and incredibly the majority actually thought the market was doing poorly.  Then again, if they listened to the news and all of the negatives I guess this makes sense.

    • 66% thought SPX was down in 2009
    • 48% thought SPX was down in 2010
    • 53% thought SPX was down in 2011
    • No data yet on ‘12

    Remember, markets peak with euphoria and I think it’s clear we aren’t anywhere close to that currently.

    The inflows into bonds and out of stocks the past few years is another great example of what the average investor thinks about equities here.  Sure, a lot of these outflows have worked their way into ETFs, but I still think that shows a major distrust of Wall Street, as investors would rather do it themselves now.

    According to data from the ICI, there has been a record 20 straight months of domestic equity mutual fund outflows.  Wow.

    Not to be outdone, we’ve seen record inflows into bonds the past few years.

    Here’s my favorite way to look at this.  Over the past 12 months, the cumulative difference between inflows to bonds and outflows from stocks is $457 billion – an all-time record.  In other words, with stocks making new multi-year highs and bonds virtually flat the past 12 months – investors simply can’t buy enough bonds.  If you buy when expectations are low, I’d stick with stocks.

    Also, the past 100 years of history would suggest being very careful when the retail crowd all agrees on something (remember this country once had a bubble in Beanie Babies).  Need more proof bonds are a popular trade?  For the first time ever, mutual fund giant Fidelity reported that it now has more assets in bonds and money markets than stock funds.  To me, I’d be underweight bonds here.

    The retail crowd isn’t the only ones to miss this rally.  Our work with option data suggests that hedge fund are drastically under-exposed to equities here and the fact that the average hedge fund underperformed the SPX for its fourth straight year shouldn’t come as a big surprise.  Four straight years of underperformance is the longest streak since ’98 according to Hedge Fund Research (HFR).  They also calculated the average hedge fund was up just 5.5% last year, as most were simply way too cautious.

    Don’t forget about Wall Street strategists.  They missed the rally as well, as their average recommended allocation to stocks is just 45% from 62% a year ago.  Considering the SPX gains last year, they missed out of some very nice profits.

    Turning to pension funds, they’ve historically been horrific market timers.  From getting out of stock in the early ‘80s, to being very net long in the late ‘90s, their tracks record isn’t the best.  Recent data shows private pension funds have just 50% of their assets in stocks, from 70% just a few years ago.  This is in line with the ’95 levels, not a bad time to get long, as the SPX gained more than 200% in five years .  Also, this is the first time in 40 years public pension funds are actually lowering stock allocations in the midst of a bull market.

    All of the above adds up to massive amounts of cash on the sidelines.  It is cliché to say, but at the same time very real.  As the realization comes once again that the end of the world isn’t going to come, there is plenty of dynamite to spark a huge explosion higher in equities.

    Lastly, a recent CNNMoney poll of various strategists and money managers (a poll I was a part of and had my 1,625 target) showed the average target was for a gain of less than 5% on the SPX in ’13.  In fact, the title of the article was “Stocks in ’13:  Get Defensive,” not exactly a ringing endorsement to embrace risky assets here.

    So there you have it.  I still think stocks are going to be one of the better places for your money, as expectations are way too low given the impressive gains we’ve seen the past few years.  Also I’d lighten up on bonds, as there are way too many people who are usually investing at the wrong time in that trade.   Finally, wouldn’t be shocked if small and midcaps outperformed and I’d be overweight those areas.

    Good luck in your trading and investing in ’13, and here’s to a happy and healthly year.  Without our health, none of this matters.

     

     

     

     

    About

    Ryan Detrick is the Senior Technical Strategist at Schaeffer's Investment Research in Cincinnati, Ohio. He joined Schaeffer’s in 2003 and is a frequent speaker and writer on stock market and economic issues and is widely sought after by financial media for his expertise and commentary. Mr. Detrick is a common guest on CNBC, Fox Business, and Bloomberg Television and has been quoted in outlets such as The Wall Street Journal, BusinessWeek, USA Today, Reuters, the Associated Press, and others. With a decade of financial industry experience in the investment and financial services area, strengths include short-term trading with an eye toward timely technical- and sentiment-based trading opportunities, and advanced option trading strategies. Mr. Detrick received a BA in finance from Xavier University, an MBA in finance from Miami University, and has earned his Chartered Market Technician (CMT).

    http://schaefferstradingfloor.com/

    3 Responses to 2013 Outlook: Why The SPX Will Be Up For A 5th Year In A Row

    1. akabeachguy
      January 11, 2013 11:10 am at 11:10 am

      “Stocks” is a pretty wide brush stroke with which to paint this picture IMO.

      There were plenty of high profile “stocks” last year (see my previous post to you) that would have put you in the poor house had you owned them.

      I know your site focuses on stocks and not index ETFs so I can understand where you are coming from. But why not take an index ETF like SPY or a 2x index ETF like SSO and avoid the sink holes that can come with an individual company?

      As for staying away from bonds, I offer up TGEIX and WAGOX, two emerging market bond funds, each up over 20% in the last year and have a 3 year average of up over 13%. TGEIX was down only 1 year in the last 12 years. Disclosure – I own them both.

    2. January 10, 2013 5:15 pm at 5:15 pm

      Is there a way to add ETF equity funds and Equity mutual funds together to get a better look at how much money has actually left equities for bonds?

      • January 11, 2013 9:04 am at 9:04 am

        Great question, Mike.

        I’ve seen it before and overall there are still outflows from stocks. But not nearly as many when you include ETFs.

        My take is this is still a sign of distrust.

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