Cheap Stocks And Greedy Investors Are A Great Combination

| January 25, 2012 | 0 Comments

I’ve said it before and I’ll say it again right now… It’s a great time to buy stocks.

Last week I made the case that the Fed will likely roll out a third round of quantitative easing (QE) sometime soon.  And when they do, stocks are going to soar.

But here’s the thing, the markets don’t need QE to move higher.  In fact, you don’t need to dig very deep to find compelling reasons to buy stocks now.

First off, stocks are cheap.

Right now the S&P 500 is hovering around 1,315.  That’s about 13.5x trailing earnings.  That’s the lowest price to earnings (P/E) ratio since the early 90s.  And it’s well below the average multiple of 15.35x.

In order for the S&P to trade at an average P/E of 15.35x, the large cap index needs to soar nearly 13% to 1,484!

Obviously, you want to be invested in stocks if they’re about to go on a massive 13% run this year.  A rally of that magnitude would wipe out all of the losses stocks suffered in the 2008 credit crisis meltdown and nearly push stocks back to the 2007 highs.

The second key is understanding why stocks are cheap.  And this one’s easy… Stocks are cheap because investors are afraid.

You see, a funny thing happened over the last few months.  Investor sentiment has gone up, but investors haven’t piled into stocks like they usually do when sentiment rises.

Investors are clearly holding back.  They’re opting for safer investments even though they’re bullish on stocks.  And now I know why… The European sovereign debt crisis has investors scared of a full blown market meltdown.

The Yale School of Management tracks how confident investors are that there won’t be a market crash in the next six months.

Confidence is back at the 2009 lows.  In other words, investors are as fearful today as they were when we were at the peak of despair over the credit crisis in early 2009.

It’s no wonder stocks are cheap… I wouldn’t invest in stocks either if I thought the market was about to crash.

Fortunately, the crash confidence index is a contrarian indicator.

As they say, the night is darkest just before the dawn.  And the peak in crash index is a sign that fear is also peaking.  As fear leaves the market, it should provide the fuel needed to kick this bull market into high gear.

Anyone who’s been around the stock market for very long knows the cycle of fear and greed never stops.  The pendulum is in a constant state of motion.

Investors swing from a state of utter despair and fearfulness to a euphoric state of greediness.  But it never stays in one direction for too long.

And based on the chart of the crash confidence, I believe we’re about to see the pendulum swing back toward greed.

As the stock market gains start to pile up, I wouldn’t be surprised to see the S&P soar to an above average multiple.  That’s usually what happens when investors get greedy.

The combination of cheap stocks and greedy investors could be just the thing to send stocks soaring.

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Category: Stocks

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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