Time to Put Money to Work

By Dan Lowrey, CFA
Manager Woodshed Investments

I'm still bearish on analysts' estimates for corporate earnings next year. I believe they are too high. But even still, my estimate for corporate earnings next year ~ $67 for the S&P 500, based on current labor productivity, puts the forward operating P/E ratio for the index at 16, below the historical mean of 19.

With expected additional fiscal stimulus and a very gradual reversal in the unemployment rate, I'm forecasting the S&P to be around 1270 by early next year, almost 16% higher than today. My estimate is derived based upon the current civilian labor force, which today is about the same size as it was in 2004. Baring any unforseen shocks to the market, such as higher than expected unemployment, we should have operating earnings similar to that year, in my opinion.

Driving stocks further upwards, is most directly linked to accomodative monetary policies worldwide (cheap cost of funds with rates at almost zero here in the U.S.) Retail investors are still sitting on the sidelines. But the current pop in risky asset prices is being driven by investment banks and institutional managers. I forecast another strong quarter for investment banks as they seek to borrow for almost nothing and put this money to work in higher-performing equity and bond markets, especially those dominated in outperforming foreign currencies. Additionally, institutional investors (mutual funds) are chasing performance as the year draws to a close.

I'm recommending a 10%-15% over-weighting of the market account, with an emphasis on large cap equities and the technology sector in particular. (Note: This is a tactical asset allocation recommendation and short-term in nature. Strategic asset allocation decisions should be maintained in the long-run and apply to each individual's investment objectives and constraints. Consult your financial adviser for an appropriate strategic asset allocation.)