How High Will Stocks Go?

However, there is one more thing that could be the harbinger of the next bear. That would be a dramatic rise in interest rates.

At first it would be good for stocks as investors would lose more money in bonds and switch to stocks as a more attractive alternative. Yet the higher rates go, the more it calls into question the true value of stocks.

Note that the inverse of the PE ratio is another important valuation metric called the "Earnings Yield". Right now that stands at 6.3% (given $130 in estimated EPS for the S&P 500 next year). That 6.3% earnings yield is still very attractive versus the current 2.3% yield on 10 year Treasuries as the average historical spread of these investments is 3%.

So now imagine that there is a whiff of inflation in the air. Or our politicians botch up our debt situation. Or the Fed raises rates too fast...any of which could get the 10 year back towards 3.5% or higher. Now stocks won't look so attractive leading to a stiff decline.

I do not fear any of these nasty scenarios playing out any time soon. In fact, even the Fed has made it clear that the slope of rate increases will be slow and steady as not to disrupt the economy. But good to know all the potential signs that would lead to the next bear market.

And My Crystal Ball Says...

The best outcome for 2015 is that stocks start trading up to 18X next year's earnings estimates. That would give us a target of 2340. Yet, this year has too many question marks abounding:

1) What happens with Greece and ripple effects to the rest of the European economy?

2) Is China's stock market decline a sign of a looming recession there, which would harm worldwide economic growth?

3) QE in other nations is devaluing their currencies...which makes the US dollar more expensive...which hurts US exporters. Will this situation worsen?

These question marks have limited the upside for US stocks this year. Unfortunately, I think that will continue a while longer. As such, I predict that 2150 to 2200 is as high as US stocks will get this year.

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