The best time to pick up outsized gains is when everyone's bearish. And there's plenty of bearishness on the Street right now.
Third-quarter earnings were flat, with margins compressing for the first time in three years. Fourth-quarter and 2013 gross domestic product (GDP) estimates have been trending lower into the New Year. And as always, there is concern about stability in Europe and slow growth in China.
But that bearish sentiment isn't a signal to avoid stocks. In fact, it's the exact opposite. It's the perfect foundation for a big rally.
Bearish sentiment is the perfect foundation to push the S&P 500 another leg higher. Despite the problems and uncertainties with the global economy, there are still a number of reasons why the S&P 500 could hit an all-time high in 2013. And that's going to mean big gains for investors who are buying right now.
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With this in mind, here are five reasons why the S&P 500 will hit an all-time high in 2013.
1. The Fed
Asset prices and stock prices in particular are affected by "flow." Flow is basically a fancy name for cash. As long as the Federal Reserve is pumping cash into the market, then stocks could keep rising. And we haven't even seen inflation yet. If inflation shows up, then stocks could get another boost.
But it's not just the Fed; other central banks are in on the action too. Japan and England have also been pumping cash and devaluing their currencies. While that's bad for the consumer, it's good for inflation and the economy. The race to the bottom of currencydevaluation and the river of cash from the central banks could support asset prices and stocks in particular. The central banks have used some big bullets, but in the big picture, they are deep into a very risky hand and showing no signs of backing down.
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2. China done tightening
China's economy continues to slow, which has been a drag on the global economy.
China's slowdown has been driven partially by anti-inflationary measures taken by the government, increasing reserve requirements and reducing lending volumes between national and regional banks. But now, China is at the end of a tough two-year tightening schedule that has seen their stock market fall three years in a row. Rate and reserve stability will give the market more room to breathe. Any loosening in rates or reserve requirements could give the Chinese and global economy a nice jolt.
3. Fiscal integration in Europe
Europe is still a total disaster, but the European Union (EU) has recently taken steps to increase fiscal integration.
Although this is controversial from a social perspective, fiscal integration is important because it sets a standard for two countries sharing a currency to also share fiscal responsibilities with government tax and spending. This issue is particularly relevant in light of the fracture between creditor EU countries like Germany and debtor EU countries like Italy and Greece. While controversial, fiscal integration would be viewed as a positive on the Street. The EU continues to defy an implosion. Expect Europe and the EU to go all in and exhaust all possible options before letting the euro and euro zone fall apart. And that can go on a lot longer than most people think.
4. Earnings at all-time high
The economy isn't great, but corporate earnings are.
The S&P 500 is projected to earn $112 per share in 2013, well past the high in 2007 of $90 before the financial crisis, according to data from FactSet Research Systems. But back then, the S&P 500 was trading at 1,565 points, an 8% premium from current levels. That compelling valuation shows up in the long-term trend. The current forward P/E (price-to-earnings) ratio of 12.6 times is below the ten-year average of 14.2 times, according to FactSet. For a market desperately searching for inflation, there is not very much inflation premium-priced into stocks right now.
5. The chart
The S&P 500 chart looks a lot like it did last year. Stocks were crashing in October and November before launching a turnaround in December that kicked off a ferocious six-month rally that lasted until May with a new multi-year high in hand.
Stocks are repeating that same pattern right now, moving into position to test the all-time high of 1,565 points from 2007. That's only 7% away, meaning stocks have rarely been this high. If the market gains momentum into the high, then it could create a classic breakout formation as shorts cover and longs pile on. And all that extra liquidity from the central banks will be looking for a place to hangout for at least a few months. That could set the foundation for a strong 2013 for the averages.
Risks to Consider: There are still plenty of obstacles for the global economy, such as slow growth in China and uncertainty in Europe. Any major disruptions in either region would weigh on GDP and earnings.
Action to Take --> Sentiment isn't super bullish going into 2013, which sets the perfect foundation for a contrarian rally. The uptrend of the past three years is still well in play, which could lift the S&P 500 to a new all-time high in 2013.
P.S. -- It's finally here... our Top 10 Stocks for 2013. Since we first began publishing this annual report in 2003, our picks have beaten the market seven out of the past nine years... including average annual gains of up to 38.7% in a single year. Go here to learn more.
Michael Vodicka does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.