Five Reasons Why the S&P 500 Will Hit 1,350

by Matthew Weinschenk

Five Reasons Why the S&P 500 Will Hit 1,350

by Matthew Weinschenk, Contributing Editor

Thursday, July 8, 2010: Issue #1297

If you've talked yourself out of buying stocks recently, set aside your fears right now.

Fear is what kept many investors out of stocks when the bull market started in 2002. Seven years later, investors missed out again when the March 2009 bull market got underway.

And if you let fear take over now, you're going to miss the market's next upward swing.

Don't worry about what you read in the headlines, or hear on cable news. The headlines never tell the whole story.

Now is the time to put your money into stocks, because the S&P 500 is bound for 1,350 over the next year or two. And I'll tell you exactly why...

Fear and Fundamentals

As you know, there are two primary emotions that drive the stock market's activity: fear and greed.

And at the risk of oversimplifying things, the market is priced on two factors: sentiment and fundamentals.

  • Sentiment - the prevailing opinions of investors. Or more accurately, given the presence of fear and greed, it's the feelings of the investing community.
  • Fundamentals - the cold hard facts that indicate what the market is worth.

As an investor, the goal is to find the "sweet spot" - that is, where negative sentiment keeps prices low on companies that boast strong fundamentals.

And guess what? That's exactly what we have now - a situation that offers one of the best buying opportunities of the year.

The question is: Can you shake your fears and jump in?

Five Reasons to Buy Stocks Today

1. It's the Economy, Stupid!

While the occasional negative number gets the media's attention, there are plenty of signs that point to an economic recovery.

  • Manufacturing: Take the Institute of Supply Management's gauge of manufacturing sector data, for example. It showed expansion for the eleventh consecutive month. Breaking it down further, 13 of the 18 industries within it reported growth.
  • Housing: While the bears argue that housing starts dropped recently, they're still up over 4.4% from last year. And if you back out the data from the South, housing starts actually rose last month. No one is interested in building a new house in the Gulf area right now, which skewed the overall number. According to the Case-Shiller Index home prices are back on the rise.
  • Railroad Freight: The Association of American Railroads reported last week that freight traffic has hit its highest level since 2008. This is an important leading indicator, as increased freight shipping means increased spending from businesses and consumers.

The one laggard you can point to is private sector hiring. However, when more positive sentiment returns, this number will likely turn quickly. And it will turn so fast that waiting for a clear trend will leave you far behind.

2. Nowhere Else to Go

Low interest rates are designed to stimulate the economy - and right now, they can't get much lower than the current yield of 0.61% on Treasuries. That's giving businesses the financial freedom to expand and underpin an economic recovery.

But more than that, it means that investors looking to earn a decent return on their money have to look elsewhere. And the destination for a large chunk of it will end up in the stock market.

Whether we're talking about money managers, or the nearly $1 trillion in cash that S&P 500 companies hold on their balance sheets, that cash simply needs to flow to the stock market to earn any decent return. Which leads me to my next point...

3. The Values Are Tremendous

If Treasury yields are too low, what can you earn from the S&P? The average dividend yield of 2.13% isn't too bad... but take a look at the yields available on some of the top blue-chip stocks:

  • Altria Group (NYSE: MO) - 6.57%
  • AT&T (NYSE: T) - 6.42%
  • Verizon (NYSE: VZ) - 6.07%
  • Equity Residential Properties (NYSE: EQR) - 3.81%

That's not all. As my colleague, Marc Lichtenfeld, mentioned in yesterday's column, the forward price-to-earnings on the S&P is the lowest it's been in 15 years - around 12. That's below the historical average of about 15 and suggests that there's room for a jump to around 1,300 for the index.

The S&P is also trading under three times its price-to-book-value, 1.1 times sales and 10 times free cash flow.

By any measure, stocks are unquestionably cheap. Yet many investors refuse to accept it.

4. Misguided Sentiment

Fear pervades the market.

Take the AAII Investor Sentiment Bullish Reading, for example. It's currently below 25. The last time it was this low was - you guessed it - March 2009.

Then there's the Bloomberg Professional Confidence Index. This reflects financial professionals' answers to the question: "Is the economy in your region deteriorating, stable, or improving?"

From a reading of close to 60 points in May, it tumbled to 26 points in June - well into "deteriorating" territory.

Consumer confidence isn't quite as bad, but the latest gauge is still low.

There's a disconnect here between people's opinion of the economy and stock market and the actual reality. Opinions are negative, but several important economic indicators are positive.

And that's before the most important indicator even comes into the picture...

5. Earnings Season Starts on Monday

In just four days, Alcoa (NYSE: AA) will kick off another earnings season. And guess what we'll see from this round of reporting? Companies are growing.

Earnings for the companies in the S&P 500 are expected to jump by 22.5%, with revenue expected to rise by 8%.

Simply put, that's not an economy in recession, or even in distress.

So there you have it. All that's left to say is that if you don't buy shares of growing companies, with the market trading at 12 times its forward price-to-earnings, I believe you'll miss out on a serious bull run.

But you don't need to take my word for it. Since you'll find few others making the same claim, that should tell you all you need to know!

Good investing,

Matthew Weinschenk

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