Bull vs. Bear Markets

11/28/2011 12:01 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

Gauging the market outlook requires more than an analytical ability. It requires an extensive historical perspective that allows one to fully assess what might be different under the current situation. And it requires an objective cornerstone that is not easily shaken even in the midst of emotional mayhem.

As one looks at the market today, there is no denying that the recession forecasts and European debt crisis are having a significant effect on both investor and consumer fears. Consumer confidence is at two-year lows. However, there's also significant evidence contradicting the widely held belief that the US is heading back into recession.

For example, it's extremely rare for weekly jobless claims to drop to a six-month low­-as they did in October-if the economy is on the cusp of a recession. In fact, it has never happened. And the US Leading Economic Indicators remain in an uptrend, recently hitting new recovery highs. When has that occurred in the six months prior to a recession? Again, the answer is, "Never in the 52-year history of the LEI data."

Based on trailing earnings, valuations are well below historical norms. Yet what makes today's valuations even more compelling is the ultra-low level of interest rates and lack of investment alternatives. It's very rare to see the S&P 500 dividend yield exceeding the yield on a 10-year Treasury bond-as it does today. And with a current P/E ratio of 14.7, the S&P 500 Index is trading at over a 30% discount from average valuation levels when short-term interest rates have been under 3%, let alone near 0%. All of this raises the question of whether 2012 might provide sizable profit opportunities for investors if the widely anticipated recession fails to appear.

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