The saving grace for stock market investors is its valuation. Corporate earnings are expected to be pretty decent in the upcoming fourth-quarter reporting period. They are also expected to be good in the first quarter of 2012. This, and reasonable valuations will help hinder major stock market downside over the near term.
I wouldn’t be surprised at all if the stock market in 2012 performed similarly to 2011. Last year, stocks moved nicely higher for the first two months of the year, consolidated, then corrected. And it wasn’t as if there was some major reduction in expectations for corporate earnings; it was the sovereign debt crisis in the eurozone that held the U.S.stock market back. Even with lackluster economic news, I firmly believe that share prices would have been stronger last year if European policymakers (especially in Greece) did a better job. Naturally, these kinds of things are beyond the control of investors. Politicians, it would seem, are extraordinarily gifted at creating uncertainty in capital markets. (See The Debt Crisis & the Great Euro Reckoning—What the Fallout Means to Americans.)
The New Year is always about new beginnings and I feel there is a solid possibility that the stock market will advance over the coming weeks. We’ve had some earnings warnings, but mostly, they’ve actually been revenue warnings or specific corporate events (like the warning from Intel Corporation [NASDAQ/INTC] due to a weak supply of hard drives from Asia). Companies, especially big-cap companies, are very good at maintaining their corporate earnings, even if revenue growth is falling. With the stock market trading at a fair price and fourth-quarter corporate earnings likely to surprise, we have the makings of some breakouts in the major stock market indices.
The S&P 500 Index is definitely fighting to break out of its recent trading range and, while trading volume has been exceedingly light, 1,300 on the index is an important benchmark. It will be a very positive development if the index can hold above this level.
According to Bloomberg, the S&P 500 Index traded at an average price-to-earnings ratio of 14.1 in 2011. The index has a 50-year mean price-to-earnings ratio of approximately 16.4. Bloomberg calculates that the current Wall Street consensus for corporate earnings growth in 2012 is 9.7% to $108.38 per share on S&P 500 earnings, which is an all-time record. This puts the stock market’s current price-to-earnings ratio at approximately 11.6 times forecast corporate earnings for 2012. Regardless, the stock market is not expensive or overvalued historically.
We’ve had some surprises already in some industries (like retail and transportation), but also some disappointment (large-cap technology). My feeling is that 2011 fourth-quarter corporate earnings will come in stronger than expected and so will the first quarter of 2012. If we don’t get another war and the eurozone debt crisis doesn’t take over, the stock market has solid potential for a 10% gain this year. That is, of course, if the politicians don’t mess it up.