Six Reasons Stocks Will Move Higher

05/05/2008 12:00 am EST

Focus: MARKETS

David Fried

Editor, The Buyback Letter

David Fried, editor of the Buyback Letter, says the big picture favors higher stock prices, and he lays out the reasons why.

Underneath the market noise (and there is a lot of noise these days) are solid realities that ultimately rule the day no matter what investors’ near-term hopes or fears may be.

Big Trend #1: Since 1920, the Standard & Poor’s 500 index has gone up an average of 15.5% when inflation was in the 2%-5% range. Currently, inflation is running well below the 5% mark. The inflation trend remains very positive.

Big Trend #2: Peter Lynch, the famed fund manager of The Magellan Fund during its glory days, said when yields on long-term government bonds exceed the yield on the S&P 500 by 6% or more, sell stocks and buy bonds. The current yield on the S&P 500 is 2.2% while the yield on 30-year government bonds is about 4.40%. The difference between the two yields is 2.4%.

Big Trend #3: [The Federal Reserve has cut short-term interest rates by more than three percentage points]. The Fed has also indicated it will do what is necessary to keep the economy in good shape.

Big Trend # 4: Currently the 30-year bond currently yields 4.5%, 2.1% more than the
2.37% yield on two-year paper. The spread between two-year paper and the ten-year note (yield 3.77%) is 1.4%. The yield curve spread is in order.

Big Trend # 5: The increase in the market so far this year did not increase the P/E ratio of the S&P 500 as earnings have increased as well. The S&P 500 trades at about 21x earnings. This is a little higher than the ratio we have had in recent years. But given current low interest rates, it is hard to make the case that stocks are drastically overvalued.

Big Trend #6: We add the total bullish percentage readings of Investors Intelligence, Consensus Index, AAII Index, and Market Vane and average this figure for the month. We consider an average reading of more than 200 to be negative while readings of less than 150 are positive. The average total reading for the month ending March 31, 2008 was 136.22. Readings of about 130 or below have marked market bottoms.

Big Trend #7: The broadest measure of money supply available is called M2, and currently, it is up about 7% from the same time last year (end of January reading). An expanding money supply is bullish for equities, and this is a major expansion.

Six of our seven indicators are positive (inflation, dividend yield, yield curve, money supply, sentiment, and the Fed), and one is neutral (valuation). None of our indicators are negative, and that is only the second time it has happened! Our indicators are telling us the investment climate is positive.

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