Reaching Escape Velocity?

The stock market has been flirting with five year highs – but not breaking through to all time highs – for a  week now. We are at an inflection point in the markets, for both stocks and bonds, and the coming days should tell us whether we will finally reach escape velocity and surge to all time highs on the Dow and the S&P, or whether it’s back down to the trenches for who-knows-how-long. 

The strongest argument for new highs and a new bull market is valuation. The PE on stocks is low. Depending on how you measure it, it’s around 13 give or take. The last two times we’ve been near these levels on the S&P, the PE was 26 and 15 (2000 and 2007, respectively). Twenty six was ridiculously high and 15 was not enough to produce escape velocity, apparently – because we didn’t. Implied returns from a PE of 13 are around 13% per year over the next five years – certainly better than most bonds. The average PE after a recession-recovery cycle is 13.9 – higher than where we are now. So from a valuation perspective, it should happen. We should reach new highs and head to orbit.

But assets can stay cheap for what seems like forever. The intrusion of government into the private economy, troubles overseas, and countless other “products of the milieu” are very worrisome and have convinced many investors to sit on the sidelines. 

Hold your breath, because this battle between the bulls and the bears is about to be decided. A win by bulls will have us off to the races, and stock investors will be very happy indeed. A win by the bears consigns us to another long hibernation.