As easy as it was to be bearish in 2009, it sure didn't pay. The S&P 500 ($INX) is poised to end the year with a 25% total return -- a stellar performance by historical measures and something that was inconceivable when equities were in freefall back in March. Now, as Wall Street trots out its 2010 market forecasts and as bubbly as things may look, there's ample reason to think stocks can climb even higher before potentially going pop.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%The Street's average price target on the S&P 500 for this time next year stands at 1,223. That's a 10% gain from current levels and would equate to about 11,455 on the Dow Jones Industrial Average ($INDU). Of course, no one knows if we'll get there, only that if we do, it won't happen in a straight line.
The U.S. recovery, such as it is, is forecast to be weak, and unemployment is expected to stay stubbornly close to 10%, yet equities don't much seem to care. There's simply too much liquidity sloshing around at the same time as corporate profits are coming up against almost preposterously easy comparisons.
"The basic foundation that has been driving this market is still intact and improving," says Dan Genter, CEO of RNC Genter Capital Management, a Los Angeles investment management firm. "The equity market is being driven by positive earnings momentum -- the same thing that drove it 100 years ago and will drive it 100 years from now."
To Boost the Markets, Fear Is Good
At the same time, unprecedented levels of cash are still sitting on the sidelines, which limits potential market downside, inasmuch as it should serve to suck in bargain hunters or anyone waiting on a pullback. "Additionally, professionals who have held high cash positions and missed the current upswing will be forced to deploy cash into weakness since this ball and chain has caused them to significantly underperform their benchmarks and their peer groups," Genter says.
In other words, never underestimate the importance of career risk. Jeffrey Saut, chief investment strategist at Raymond James & Associates, has been harping on that point throughout the market's magical mystery rally, and it has served his clients well. Fundamentals and technicals are nice, but there's nothing like fear to make the market move higher. As Saut reminded clients again last week: "Under-invested portfolio managers chase stocks driven by performance pressure, bonus pressure, and ultimately job pressure."
Indeed, as pricey as stocks look on a normalized earnings basis, all that money sitting on the sidelines is an argument against them being in bubble territory just yet, if only because the vast majority of money chasing a bubble comes in at the very end. Thomas Villalta, co-portfolio manager of Jones Villalta Opportunity Fund (JVOFX), argues that mutual fund flows and money market balances do not support the assertion that the stock market is irrationally priced. "Indeed, they make the case that the market is undervalued," he says. "Irrationality in any market rarely comes without the aid of a significant influx of funds into the market in question."
A Solid Recovery Isn't a Necessary Condition
There's also the case that fund managers are pretty bullish on equities heading into 2010, with expectations for corporate profits at their highest level since 2003, according to a survey by Bank of America-Merrill Lynch (BAC). More than 60% of fund managers see earnings growing more than 10% in 2010. That would certainly support another 10% upside in stocks at current multiples -- and seems doable in light of the scorched-earth policy U.S. companies have taken on slashing costs.
Super-bear David Rosenberg, chief economist and strategist at Canada's Gluskin Sheff, makes a cogent case that we're still a long way from a sustainable recovery, but he readily admits that doesn't mean risk-chasing investors can't push equity prices even higher. "Since 1989, the Japanese stock market has had no fewer than four 50%-plus rallies, and there still has been no period of growth that can be called a sustained expansion," Rosie told clients on Thursday.
It behooves investors to be cautious and focus on capital preservation -- but there's no sense missing out on any remaining upside. As much as we see bubbles, bubbles everywhere, the faith-based rally in stocks looks capable of sustaining itself in 2010.