It’s a difficult call to say that the stock market will be lower at the end of 2012. There are some serious factors on the side of higher as well as lower values. On Wednesday, we explained some of the reasons why we think 2012 will be another extremely volatile year for the markets.
Today, we’ll cover some of the reasons the market could go much higher and also why we think the market will instead, end lower. We live in interesting times and the confluence of possible events will be what determines where the markets go. All we can do is guess which events will occur this year.
Currently, the stock market is priced reasonably. It’s just below its long term Price To Earnings (P/E) Ratio of 16 at around 14.5. This means that the stock market is priced below its long term average.
This fact has many professional money managers drooling at the possibilities for the year because if a Black Swan event doesn’t show up to take the markets down the markets will probably climb this wall of worry in dramatic fashion to have a great year. Many people believe that the fears are overblown and will be dealt with. That’s what’s always happened before, right?
Well, for as long as we’ve been alive perhaps, but no, that’s not how it always goes. Every 80-100 years there’s really a very tumultuous change that occurs.
We talked last time about some of the things which could cause the market to crash. There are actually many other s we could add to this list, but in this post, we’re going to focus on the markets themselves.
Investor sentiment at the moment is very bullish. This is actually a negative indicator on the market in the short term because if everyone has already bought, there’s no one left to buy. We’re not sitting at extreme bullishness right now, so there’s still a ways it could run, but the market is also overbought. This appears to be a setup for the market to give back the impressive early year gains that it’s made sometime relatively soon. What happens after that? Again, it depends on those black swans.
Yes, P/E Ratios are reasonable, but they are not cheap. Typically, a long term market cycle bottom will see P/E rations about half of where they are now. The Dow should be paying high single digit dividends. Neither of these is remotely true. This tells us that the real bottom is not in yet. (Of course, nothing says the real bottom has to come this year, it could come in 2013 or 2014.)
Another point to consider is that corporate earnings margins are at extreme highs. This means that they they are making incredible profits on their sales. The nature of business is that competitors will undercut these profits. This is why corporate profit margins tend to rise and fall like waves on an ocean. They’re very high right now. This means they’re much more likely to fall than rise. This would mean falling corporate profits which would spook the market and send prices lower. It’s hard to predict this exactly, but it’s due to happen sometime fairly soon.
Looking back at the big picture…When the long term market cycle low is in, no one will own stocks. Everyone you talk to about it will think that only a fool would buy a stock. That’s what a market low looks like. We’re not there yet.
So while we do believe that’s coming. It’s much more difficult to say what exactly will happen in the next 11 months. For instance, we could have the economy and markets show more weakness and then the Fed announces a huge QE program and the market takes off. It could end up up for the year even with bad economic data.
In conclusion, it’s pretty difficult to predict what will happen specifically in the stock market over the next year, but it definitely feels like it will see some extreme downdrafts this year, and we’re going to pick it to end that way.
This is the sixth post in a series. You should read the initial thoughts on these forecasts here. and the Overall Prediction Page here. Here are the rest of the posts: 3) Ben Bernanke’s Dollar Devaluation Plan, 4) The Coming US Dollar Devaluation, & 5) Stock Market Volatility. You can also watch the most recent series of Economic Update videos at: 1) European Debt Crises, 2) European Debt Crises 2, 3) MF Global, 4) Gold & Silver Pt 1, 5) Gold & Silver Pt 2, 6) Gold & Silver Pt 3, 7) World Economic Update., 
World Economic Update 2, 9) The Chinese Economy, 10) Inflation or Deflation Concerns?, 11) Inflation Concerns Pt 2, 12) US Economic Update, & 13) US Economic Update 2.