How High Will the Market Go?

by Sam Collins | March 8, 2013 7:39 am

Financial stocks took the lead Thursday as the major indices achieved new highs for the third straight day. This surprised most analysts since the results of the Fed’s first round of stress tests of banks were scheduled to be released after the close of trading. Nevertheless, the Financial SPDR (NYSE:XLF[1]) rose 0.7% while the S&P 500 gained 0.3%. Bank of America (NYSE:BAC[2]) was the clear leader, up 2.85%, and JPMorgan Chase (NYSE:JPM[3]) rose 1.2%.

After the close, the Federal Reserve said that 17 of the 18 largest banks could weather a sharp economic downturn. Only Ally Financial (NYSE:ALLY-PB[4]) failed the test, while The Bank of New York Mellon (NYSE:BK[5]), State Street (NYSE:STT[6]) and American Express (NYSE:AXP[7]) were the strongest of the large financials.

At Thursday’s close, the Dow Jones Industrial Average was up 33 points to 14,329, the S&P 500 rose 3 points to 1,544, and the Nasdaq gained 10 points at 3,232. The NYSE traded 708 million shares and the Nasdaq crossed 376 million. Advancers were ahead by 1.5-to-1 on both major exchanges.

Now that the stock market has achieved a historical breakout, the question is, how far will the advance take us?

The short-term answer is a correction could occur at any time. That’s because the market is still subject to negative headlines and the impact of an infinite number of potential disasters.

But longer term, the most accepted method of targeting the breakout is S&P’s earnings multiplied by an anticipated price-to-earnings (P/E) ratio. Currently, the estimated earnings for the S&P 500 range between $105 and $110, and the current P/E is estimated at around 14. Dr. Jeremy Siegel, a Professor of Finance at the Wharton School of the University of Pennsylvania, said on CNBC Thursday that the long-term average P/E for the S&P 500 is 15, which would equal 1,650 as a target, using $110 earnings. But, Dr. Siegel pointed out that in periods of low interest rates, the P/E rises to 18-19. Using 18, the target would be 1,980.

SPX Chart
Click to Enlarge

Trade of the Day Chart Key[8]

Straight chart analysis provides a different answer. Let’s assume that the breakout of the S&P 500 really occurred in January, from a version of a reverse head-and-shoulders at the level of 1,475. Based on this pattern, the target for this year would only be 1,607.

How did I arrive at this number? The November low of 1,343 is subtracted from the breakout point of 1,475 for 132 points. Add 132 to 1,475 and you get 1,607. Simple, yes, but most often simplicity trumps complexity, and so I’ll stick with that target until proven otherwise.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[9].

For a list of this week’s economic reports due out, click here[10].

  1. XLF:
  2. BAC:
  3. JPM:
  4. ALLY-PB:
  5. BK:
  6. STT:
  7. AXP:
  8. [Image]:
  9. click here:
  10. click here:

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