Sunday, January 28, 2007

AEI Market Outlook

John Makin at the American Enterprise Institute has a new article about the outlook for the market in 2007:

As we enter 2007, many market commentators describe themselves as "cautious" concerning the stock market. They should not be. The major determinants of stock prices are expected profits and interest rates. Both factors are currently supportive of higher stock prices. Profits are expected to rise by about 10 percent during 2007, while interest rates should remain stable and may even fall, providing further support for stock prices.

Makin's outlook is more optimistic than ours but this article makes a good case for stocks:

Based on historical norms since 1985, the current yield on ten-year government notes (about 4.75 percent) and the projected earnings of the companies in the S&P 500 stock index over the next year suggest that the present level of that index--about 1,420--equals only about 80 percent of its "fair value." In other words, if we take our bearings from expected earnings and interest rates, if the stocks in the S&P 500 were currently valued as they have been on average over the past twenty years, the index would be at 1,775 instead of 1,420.

I'm more concerned about rates and it appears the market is as well. Expectations for a rate cut this year have essentially been removed from the market and that is the source of the recent hesitation in the market. However, I expect earnings to be better than expected as growth seems to be accelerating again and that could indeed push the market closer to fair value.

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