How High Will Stocks Go?

Stocks have rallied over 200% from the depths set in March 2009. That includes a healthy 13.7% gain for the S&P last year. Unfortunately this year things seem to be stalling out. That begs the question:

How high will stocks go?

I will explore that topic by first looking at the best case scenario. Then the worst case. And for good measure, I will give my prognostication of how it will all play out.

Hey Goldilocks! Best Case Scenario

Plain and simple the bull market will stay in place until one of two things happens:

1) Recession appears on the horizon.

2) Stocks become ridiculously overvalued and the bubble bursts (like in 2000).

Right now the US economic data shows no signs of a recession in the air. Yes, Q1 was modestly in negative territory, but that was due to transitory factors like bad weather. Economists are in strong agreement that we will return to 2-3% GDP growth ahead. So no problems here.

And yes, stocks are getting pretty fairly valued these days. However, history shows that most bull rallies don't end until way past fair value...what you might call "fully valued". That could be at a PE of 18-20. Whereas the S&P is only trading at 16X next year's earnings estimates.

So the best case scenario is that the economy returns to a healthy 2-3% growth pace. That, plus the aforementioned PE expansion, should lead to the market making new highs once again in 2015. And if the economy keeps expanding in 2016...then stocks will progress even higher.

Long story short, you should stay fully invested in this market until a recession appears imminent or stocks become bubblicious.

Look Out Below! Worst Case Scenario

The previous section provided the two main elements (recession and valuation) that would lead to the worst case scenario and full blown bear market. Note that the average bear rips out 34% from stock market valuations. That is actually a good scenario if you see it coming and get short in time to profit from the move with shorts and inverse ETFs.

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