The Market Going Forward...

A guy at the gym approached me early this morning and said "Hey Marty, pretty good year for the market huh... what's next year look like?" I replied "ask me this time next year and I'll tell you for sure." Not pressing for a prognostication, he kindly grinned and headed toward the dumbbells (as in weights, not his fellow weightlifters). Clients, however, are generally not so charitable, they want to know what I really think.

So for you clients, and interested subscribers, out there, here are a few thoughts on just two (brevity for now) tone-setting factors: Sentiment and valuation. I'll characterize each point as bullish, bearish or neutral. At the end I'll tell you what I really think:

(For meatier commentaries from me read Cycles, Sectors and Monetary Policy Confusion, and year-end 2012's Our View Going Forward [which, while I'll update it soon, largely remains our view going forward]).

Sentiment:

40% of the participants (everyday folk) in a new Associated Press-Gfk poll say the market will finish next year at about where it is right now. 39% expect it to finish lower (but not crash), 5% expect it to crash, and a mere 14% expect it to rise. That sort of bearishness---as I've explained many times over the years---is a bullish sign.

The latest Investor Intelligence sentiment survey says that better than 50% of advisors are bullish. That sort of bullishness---as I've explained over the years---is a bearish sign.

Valuation:

Trading at 16 times next year's earnings, the S&P 500 (not considering interest rates) is just okay: neither cheap nor expensive. Neutral

Trading at 16 times next year's earnings, while the yield on the 10-year T-bond is below 3%, the S&P 500 is attractive. Bullish

If interest rates (yields) rise, and earnings don't improve, stocks are expensive. Bearish

If interest rates rise, and earnings do improve (as you'd expect if rates rise in response to a faster growing economy), stocks are attractive. Bullish

If interest rates fall, and earnings hold, stocks are attractive. Bullish

If interest rates fall, and earnings fall (as you'd expect if rates decline in response to a slowing economy), stocks are expensive. Bearish

Okay, I'll throw in one economic data point, just because it came out today:

Industrial production for November hit a new all-time high. Suggesting (maybe) that the U.S. economy has finally shifted from recovery to true expansion mode. Bullish

Industrial production for November hit a new all-time high. Another reason why the Fed should start tapering QE now. Bearish (maybe), short-term.

What I really think:

I really think there's cause for optimism going forward. For one, companies have deftly managed their bottom lines throughout the recovery: If indeed the economy is on the verge of reaching escape velocity, efficient businesses (attractive margins) translate a large percentage of revenue (growing in a better economy) to earnings. Higher (than expected) earnings = higher share prices. And I remain in the camp that believes that, to date, the present bull market has lacked participation. I.e., a lot of folks, still shell-shocked from 2008, have yet to engage.

I, sorry, also really think there's cause for pessimism going forward. For one, interest rates have been so suppressed (by the Fed) for so long that there's no telling how aggressively the bond market will seek its long lost equilibrium. A rapid rise in interest rates would surely slow the economy, call earnings into question, and, therefore, do a real number on stock prices. Lack of engagement or not, those still-shell-shocked-from-2008 investors may not be willing to buy the kind of dip such a scenario might inspire.

Trust me, I can take any other factor---the dollar's potential reaction to less QE, the recovery in Europe, capital controls in emerging markets, the trend in gold, politics, national debt, potential inflation, potential deflation, mid-term election prospects, the U.S. energy boom, Mexican manufacturing expansion, the Affordable Care Act, a hike in the minimum wage, etc.---and paint red, green and grey pictures ad infinitum. The fact of the matter being, while because the clues are so numerous---actually, innumerable---I don't have one as to what the near-term might bring. Which is why I am such a critic of outright market timing (that is, moving in and out of the market itself, as opposed to rotating among sectors).

Bottom line: The long-term investor's allocation to the stock market should reflect his/her temperament and time horizon, never his/her own, or someone else's, glomming onto one, or one hundred, data points and trying to guess what might happen over the course of any 12 month period.