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U.S. Stocks

What a Little-Known Market Tool Is Telling Us About U.S. Stocks in 2012

If you're a longtime investor, you're no doubt familiar with the Price/Earnings (P/E) ratio - a common measure for valuing the stock market.

But you may not be as familiar with the more-obscure Earnings/Price (E/P) ratio, which some experts refer to as the "earnings yield" on stocks.

If you're not familiar with the earnings yield, it's time to brush up.

While it may be obscure, the E/P ratio is an important tool. It not only tells you stocks' value, it allows you to compare that value to other assets like bonds.

And right now it's telling us a lot about buying U.S. stocks this year.

Basically, the risk/reward in favor of stocks over corporate bonds has never been this high...ever.

Let's take a look.

How to Use the Earnings/Price Ratio

We can get a pretty good handle on the value of stocks if we look at the E/P ratio of the Standard & Poor's 500 Index.

In 2010, the earnings for the S&P 500 came in at $83.77. According to Standard & Poor's, the earnings estimates for 2011 are at $97.81 and will climb to $111.73 for 2012.

Taking the 2011 S&P 500 earnings estimate of $97.81 and the current S&P price of about 1,290, you come away with a multiple of 7.5% (97.81/1290). Simply put, this means that the expected earnings of the S&P 500 are 7.5% of the price of the index.

By the same token, if earnings come in at the expected $111.73 in 2012 and stock prices remain the same, the earnings yield jumps to 8.6%.

Why should you care? Because you want a higher rate of return for the risk of investing in stocks when compared to the rate of return of other asset classes.

Generally, the earnings yields of equities are higher than the yield of risk-free treasury bonds, reflecting the additional risk involved with stocks. But right now the difference is extreme, with 10-year government bonds yielding a paltry 2%. Meanwhile, corporate bonds are paying about 5%.

Now let's compare the return on stocks to the rate of inflation.

Over the past 50 years, the average earnings yield for the S&P 500 has outpaced inflation by 2.4%. When the market is above that mark, equities are considered attractive. When it's below, they're expensive.

Subtract the current core inflation rate of 1.5% from the 2011 S&P 500 earnings estimate of 7.5%, and we end up with 6% - well above the 50-year average. Even if we use the 3.4% consumer price index rate, you're left with a difference of 4.1%. Compare that to bond yields and you're still way ahead.

So that's where we are, but how about where we're headed?

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Why We May See a Rally in U.S. Stocks

With so much negative news dominating the headlines, investors can't be blamed for being worried or shying away from stocks. But if you take closer look at the market - specifically the Standard & Poor's 500 index - you might be surprised by what you see.

The S&P 500 is down just 3% year-to-date, and is actually up more than 5% over the past three months. The indexes for China, India, and Brazil, on the other hand, are all down over the past three months. Brazil's market index is down 19% year-to-date, China's is down more than 21% and India's is down more than 24%.

"People don't understand that the S&P 500 has now outperformed the BRIC nations (Brazil, Russia, India and China) for four years," Richard Bernstein, CEO and chief investment officer for Richard Bernstein Advisors, told USA Today. "We are in the very early stages of a resurgence of the U.S. equity markets, and I don't think people are aware of the shift that is going on."

Indeed, many analysts actually think U.S. stocks are cheap right now.

The price/earnings (P/E) ratio for the S&P 500 dropped to 12.8 as of the third quarter of 2011. The historical average for the S&P's P/E is 15, meaning stocks are moderately underpriced.

In fact, the average P/E has been even higher in recent decades. Since 1988 the S&P average P/E has been 19.2 - which translates to a 33% discount for current stock prices.

Four Reasons for a Rally

Corporate America has quietly been rebuilding since the financial crisis of 2008, but the constant barrage of bad news - the multiple disasters in Japan in March, budget battles in Washington, concern over the Eurozone debt crisis - has camouflaged much the progress that's been made.

"The pessimism today is actually creating opportunities for investors," Kate Warne, chief investment strategist at Edward Jones, told USA Today. "There are a lot of short-term concerns, a lot of serious risks, but investors really need to keep their eyes on the horizon, because we are also seeing strong fundamentals. And that is what is driving the market longer term."

Analysts have identified several positive signs - in addition to the relatively low S&P 500 P/E ratio - that indicate U.S. stocks are stronger heading into 2012 than many realize:

  • Cheaper commodities: The prices for commodities have fallen significantly since the first half of 2011, which should give corporate earnings a boost at least through the first couple of quarters of next year.
  • Lean and Mean: The fiscal discipline dictated by the financial crisis of 2008 has helped many companies weather the troubles of 2011. And now many companies are poised to quickly grow profits as soon as worries ease.
  • Dividend Increases: Companies that pay dividends have been increasing them, and that should continue. Despite the increases, the overall payout ratio has dipped to 29% from a 50-year average of 45%. Higher dividends mean a higher total return for investors, and provide some insurance against downturns.
  • More Buybacks: Buyback activity among U.S. companies rose to $439 billion in 2011 and is expected to rise to $500 billion next year. That sort of money flowing into the stock market helps boost prices.
With fundamentals strong, a run of positive news, or even neutral news, could be the catalyst that triggers a big rally in U.S. stocks.

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We Warned You U.S. Stocks Could Plunge – Here's the Safety Play You Need to Make Now

U.S. stocks reversed course in the final minutes of trading yesterday (Monday) to push the Dow Jones Industrial Average back over 11,000 - but that still wasn't enough to make a dent in the index's 4.8% loss so far this month.

Europe debt fears and dismal economic news have caused the Dow to fall in five of this month's seven trading sessions, each time by more than 100 points.

We warned you September would be a tough market month - several times.

What's more, we showed you how to protect yourself.

To continue reading, please click here...

How Bernanke Will Keep a Fire Lit Under Stocks Until Year End – And Which Sectors Will Soar

While many investors have solid reasons to remain concerned about the broader economic picture, there are some market sectors roaring forward that no one can afford to miss - and they will continue to provide profit opportunities thanks to the work of U.S. Federal Reserve Chairman Ben Bernanke.

Stocks rattled around in 295-point range of the Dow Jones Industrial Average over the past five days like pebbles in a maraca, but ended quietly -- a fraction above flat. The big-cap indexes have now posted six of their past seven closes within half a percent, hemmed in by some sort of spooky gravitational pull.

Earnings came in quite a bit better than expected for most major companies, as the cheap dollar has helped overseas sales for Caterpillar Inc. (NYSE: CAT) and McDonald's Corp (NYSE: MCD). Over in the exciting web content space, Netflix Inc. (Nasdaq: NFLX) wowed the crowd with outstanding third-quarter results, logging a sales increase of 31.0% and adding 1.9 million net new customers. That's a lot of new buyers in an economic environment that is supposed to be so terrible that the Federal Reserve thinks unprecedented medicine is required.

To read about how the Fed can keep stocks soaring, click here

The 10 Most Pressing Questions About the U.S. Economy – And Their Answers

Will the economy lapse into a double-dip recession? What can be done about the soaring U.S. budget deficit? What's next for the stock market?

These are just a few of the tough questions facing investors. And there may be no one better to offer answers, insight, and advice than Money Morning Contributing Editor Shah Gilani.

A retired hedge-fund manger, Gilani has routinely been there to shepherd investors through blinding market uncertainty. He's used his contacts on Wall Street to give Money Morning readers the inside scoop on the collapse of American International Group Inc. (NYSE: AIG), the May 6 "Flash Crash," and most recently the "Mortgagegate" scandal that currently threatens to undermine the fragile U.S. recovery.

Indeed, Gilani has been a tireless advocate for investors and a prescient market maven. That's why Money Morning's editors recently sat down with Gilani to talk about today's most pressing issues and discover what he expects for financial markets in the months and years ahead.

In the partial transcript of that interview below, Gilani discusses why it's a good time to invest in stocks, what steps should be taken to fix the U.S. economy, and whether or not gold prices have peaked.

In short, the U.S. government has failed the public as a matter of course, but there is still a way out of our current economic malaise and ample opportunity for investors to profit.

To find out the answers to the ten most pressing questions facing the economy, read on...

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Defensive Investing: Covered Calls Increase Cash Flow, Up Protection

Once you get beyond buying puts or calls for purely speculative purposes, no other options strategy is more popular than selling covered calls - and with good reason: Few investment techniques offer more potential benefits with such a low level of risk.

Considered the most conservative of all option plays, this strategy - which basically involves selling (or "writing") one call option for each 100 shares of a stock you own - can be employed for one or more of five distinct purposes:

  1. To generate a stream of additional income - over and above dividend payments - from individual stocks in your equity portfolio.
  2. To generate a stream of income from stocks you own that pay no dividends.
  3. To reduce the effective cost basis of longer-term stock holdings by bringing in option premiums, thus recovering some of the original purchase price.
  4. To provide a limited hedge against potential losses in portfolio value as a result of overall market pullbacks or cyclical downturns in the prices of specific stocks.
  5. As an income-producing substitute for a "limit-sell order" - intended to liquidate a stock position when a specific profit target is achieved.

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What We Can Learn From The Stock Market Genius That Wall Street Loves to Ignore

Mathematician Benoit B. Mandelbrot, the inventor of fractal geometry, died Oct. 14.

As mathematicians go, Mandelbrot was very likely the best of the last half-century. And that brilliance extended to the financial markets. In fact, his groundbreaking insights into the operations of the stock market could have been used to avert the 2008 crash - had those insights only been heeded.

But Mandelbrot - for all his stock market genius - has been largely ignored by Wall Street.

As investors, let's not make the same mistake.

To understand how to profit from Mandelbrot's insights, please read on...

To understand how to profit from Mandelbrot's insights, please read on...

Question of the Week: Investors Seek Metals To Soften Blow of Global Currency War

The housing market remains in the dumper. U.S. stocks - despite a rally - are still 22% below their record highs of two years ago. And the "official" unemployment rate remains at a heart-stopping 9.6%.

With their knees almost ready to buckle under such burdens already, how will American consumers respond when clothes, computer accessories and other key consumer staples at their neighborhood Wal-Mart Stores Inc. (NYSE: WMT) undergo an overnight price hike of 30% to 60%?

As the United States aims to increase exports by debasing the dollar, a global currency war is underway that could swallow consumers and investors if they don't prepare for the likelihood of a weaker dollar.

The United States, China, Switzerland, Brazil, South Korea, Australia, Japan have all entered the war, trying to bring down their currencies to boost exports and fuel growth. Countries are vying to win the "race to the bottom," as it's been called by Money Morning Contributing Writer Peter Schiff.

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Don't Miss Out on the Global Stock Rally

Indices across the world rose last week in what looks to be the beginning of a historic stock rally.

The Standard & Poor's 500 Index rose 1.6% last week, while the overseas developed-world large-caps - represented by the Vanguard FTSE All-World ex-US exchange-traded fund (NYSE: VEU) - rose 2.4%.

Meanwhile, the iShares Emerging Markets ETF (NYSE: EEM) rose 1.7%, the iShares FTSE/Xinhua China 25 Index (NYSE: FXI) rose 3%, the iShares MSCI Switzerland Index fund (NYSE: EWL) rose 3%, and the iShares MSCI Australia Index Fund (NYSE: EWA) rose 3.6%.

Among our favoried emerging markets and sectors, iShares MSCI Turkey Index Fund (NYSE TUR) blasted 6.5% higher, the Market Vectors Latin American Small Cap Index Fund (NYSE: LATM) rose 3.5% and Market Vectors India Small Cap Index Fund (NYSE: SCIF) rose 2.4%. The SPDR Gold Trust (NYSE: GLD) rose 2.1% and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) rose 2.6%.

To find out how you can participate in the global stock rally read on...

Will the Fed's Spending Drive Stocks Back Up to Their Pre-Lehman Levels?

The Standard & Poor's 500 Index is up more than 10% in the past month, and it finally looks like all of the thin threads of strength we've seen over the past few months are starting to twine together into a single rope that may be strong enough to pull stocks back up to pre-crisis levels.

The key threads are:

Even if you are skeptical of these developments, remember one thing: The Fed has absolutely flooded the financial system with money.

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The Fed's Actions Are Boosting the Bull Cycle for U.S. Stocks

News from the U.S. Federal Reserve is keeping the bull cycle for U.S. stocks alive and well. Despite investors taking a breather this week, the outlook is good for coming months.

The Standard & Poor's 500 Index fell 0.2% since Monday, while the Nasdaq 100, shown below, fell every day of the past week for a total slippage of 1.5%. The week felt a lot better than that for my subscribers because all but one of our exchange-traded funds (ETF) bets is on overseas stocks, and most rose 1.75% to 4.7%.

So we are exiting the best September since 1939, but it closed very softly for U.S. investors as the most critical earnings season in the past year looms on the horizon.

But to see why there's good news coming, read on...

Six Stocks That Should be on Every Investor's 'Don't Buy' List

With more than 8,790 publicly traded stocks on U.S. exchanges and another 7,000 or so listed on the OTC Bulletin Board and the pink sheets, it's not particularly difficult to find stocks you wouldn't want to buy. It's not even that hard to find stocks with numbers so bad they're good short-sale candidates.

What's really hard is recognizing companies whose shares seem like they might be bargains, but that actually have subtle or hidden problems. These stocks truly belong your DO NOT BUY list.

A good example is Bank of America Corp. (NYSE: BAC). The financial sector was among the leaders as the market rallied from its July lows, but BAC didn't add much to the advance. In fact, after a brief bounce, it tumbled to a 12-month low of $12.18 on August 30 - a far cry from its October 2007 high of $52.71. Still, it looks like the stock built a solid technical base during the early September market upsurge and could be poised for a breakout if its earnings, due out Oct. 20, beat expectations.

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Buy, Sell or Hold: Hewlett-Packard Co. (NYSE: HPQ) – It's Time to Sell This High-Tech Stalwart

Now's not the time to own Hewlett-Packard Co. (NYSE: HPQ). Long one of the bluest of blue chips in the U.S. high-tech sector, H-P has been in the spotlight and under the gun since its early August ouster of Chief Executive Officer Mark Hurd. And while Hurd's unceremonious resignation following an internal sexual harassment investigation […]

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Three Ways to Brace for a Double-Dip Recession

Economists are torn... Is the U.S. economy on the upswing? Or are we facing the dreaded "double dip recession"? Either way, there are a few things every smart investor needs to do now to protect their nest eggs. Find out what you should do in this free report.

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Investors' Hopes Riding on Surge in M&A Activity

Global mergers and acquisitions (M&A) activity is at its highest level since late 2009, providing a glimmer of hope to investors struggling to decipher stock and bond markets roiled by a weakening U.S. economy.

Global takeovers announced so far this year have totaled $1.29 trillion, up 23% from the same time last year, according to Bloomberg News.

Last week a flurry of bleak economic news headlined by larger than expected unemployment claims spurred a 280-point drop in the Dow Jones Industrial Average.

But, investors took some solace from a flurry of M&A activity and an initial public offering (IPO) from General Motors Co., because acquisitions are seen as a sign companies are confident the economy will grow and business will improve.

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