Why Investors Should Expect S&P 1600 by the End of 2013

This article was written with Oliver Pursche, co-portfolio manager of the GMG Defensive Beta Fund. It was part of a series of articles developed under an agreement with minyanville.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week.

Ample evidence in the US markets suggests that this new high is in the crosshairs.

If you close your eyes and tune out the noise, your portfolio could benefit greatly. In spite of all the talk of sequestration, market pullbacks, Italian politics, and so on, there are concrete reasons why I believe the S&P 500 (INDEXSP:.INX) will blow past its all-time high of 1527, set in July 2007, and reach 1600 before the end of the year.

First of all, I don’t think it’s a very bold forecast; after all, 1600 is a mere 5½% away. Moreover, as you will see in this article, in spite of politicians around the world trying their best to mess things up, headwinds have in fact turned into tailwinds for investors.

Here are the drivers that will get the market to 1600.

Rising GDP. Fourth-quarter GDP, which was initially thought to have contracted by 0.1%, has been revised upward to +0.1% — a disappointment to revised expectations, but an improvement nonetheless. Midwest factory activity, consumer spending, and other measures of economic activity have also been revised upward and continue to surprise on the upside.

Demand for autos. This one is a sleeper. But a careful look at the used car market shows low inventory and rising prices. Prices are rising to the point where the price difference between buying new or buy used is becoming negligible. And when you throw in some of the financing options available today, it’s possible for many buyers to get into a new car for less money than they are currently paying.

Light housing inventory. I was fortunate enough to take in a presentation by St. Louis Federal Reserve Bank economist Kevin Kliesen. He had a lot to say, but the most interesting data point in the presentation was that housing inventories (the number of homes available for purchase) are below 2001 levels. This sets the stage for price appreciation and an increase in housing starts. All of these are good things for the economy as existing home sales fuel nearly every other sector of the economy.

Low, low interest rates. The current interest rate environment is challenging for retirees and near retirees. However, it’s a potential boon to the economy given the current dynamics in the housing market. Specifically, this low inventory — combined with rising values and cheap money to make purchases — is a positive development for all of the industries attached to housing such as carpet, paint, appliances, hardware, electronics, and lawn care equipment.

There are noises coming out of the Fed that policies may shift toward encouraging higher rates sooner than promised, but I don’t see them materializing. In fact, I don’t expect a change in policy in 2013 or 2014. As this becomes more evident, in combination with a rising GDP, the improved fundamentals will power US equities higher. I am on record saying that low interest rates will prevail for the balance of this decade.

Rotation, Rotation, Rotation. I believe the risk trade is on. Recognize this: Pension fund assets in the US are about $9 trillion, according to the Investment Company Institute. A pension fund would rather lose a little in fixed income than lose something like 15% in equities. However, if they are earning 2% to 4% in fixed income, and paying out 7%, that’s not a sustainable performance over time. Pension fund assets will ultimately have to migrate into equities and this will help fuel the rise of stocks. By the way, the numbers are compelling. To put the $9 trillion of holdings in pension funds in context, the entire market capitalization of the New York Stock Exchange is about $14.1 billion.

After years of money staying on the sidelines and or in fixed income, I believe the great migration has begun. Fund flows from money markets in December and January (and most likely in February as well) into equities have steadily gained steam.

Naturally, it’s not all roses out there. Risks abound. But if you’ve been a bear these last few years, you have missed out on some compelling gains. I believe that, for the aforementioned reasons, an S&P 500 index reading of 1600 is just around the corner.

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