In March 2009, the stock market started its current bull run. At first, it was a V-shaped bounce from the 2008 Panic lows after mark-to-market accounting was changed.
Next, as the economy recovered, earnings drove stocks higher. But, between May 19, 2015 and November 3, 2016, the Dow Jones Industrials Average actually fell 2%, while other indices stagnated. A sharp drop in earnings (due to lower oil prices) and election uncertainty caused angst.
Since then, however, the Dow is up 19% and the tech-heavy NASDAQ is up 22%. Good policy ideas beget good stock market outcomes.
Last December we set our year-end 2017 stock market targets at 23,750 for the Dow and 2,700 for the S&P 500.
At the time, these targets seemed wildly bullish to many investors. Now? Not so much. We need barely more than an 11% increase in each index to hit those targets.
We weren't counting on better tax, spending and regulatory policy to reach those targets, but if that happens, our targets might be too low!
We use a Capitalized Profits Model (the government's measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks. Using a current 10-year Treasury yield of about 2.3% says the S&P 500 is massively undervalued. We won't tell you the number because we think the Fed is holding interest rates artificially low.
Using a more rational 10-year yield of 3.5%, fair value for the S&P 500 is 2,700, which is our target. The model needs a 10-year yield of 3.9% to conclude the S&P 500 is already at fair value, with current profits.
As always, it's important to recognize we are not market timers and aren't saying a correction won't, or can't, happen. Corrections come and go. But market timers get burned time after time. In other words, if another correction hits in the near future, stay long and buy more.
Late last year we thought the Fed could do four rate hikes in 2017. It now looks like three. And with over $2 trillion in excess reserves, the Fed is a very, very long way from creating a tight money environment if and when its starts to unwind QE.
One change to the financial picture is on long-term interest rates. Six months ago, we thought the 10-year Treasury yield would finish 2017 at 3.25%. Now we think 3.00%. That's a headwind for fixed-income investors, but with growing profits, rising rates are less of a problem for equity holders.
As has been true since 2009, those who stay optimistic will be richly rewarded. Especially with a better set of fiscal policies. Stay optimistic and stay invested.
This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.
© First Trust Advisors
© First Trust Advisors
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