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The core driver of stocks in the latest rally?  -- In my opinion, a move down in the still too high Equity Risk Premium.  The S&P 500 Equity Risk Premium moved from around 6% three months ago, to about 5.3% now. 

Internals in this rally are instructive:

  • I took a look at a Forward 12-month Price/Earnings ratio chart this morning.  It showed stock valuations stretched towards a 14 level on the S&P 500 Index in the latest rally. Still pretty low historically.
  • Consumer Discretionary and Consumer Staples are near one another at around a 16 P/E.  In the latest rally, Discretionary valuations moved ahead of Staples.  Consumer stocks are the growth areas of the economy and are priced as such.
  • With its relatively high free cash flow yield, investor’s search for safety pushed up Telcos valuation.  However, these defensive stock forward P/E valuations came down of late. They are still the highest though.
  • Financials are still the worst in terms of forward P/E ratios.  However, these stocks valuation multiples are among the highest accelerators in the latest rally.  Less fear in financials helps.

Since lowering fear and adding risk is the story of rising S&P 500 stocks, the question I have is this.

First, what LOWER RISK is taking stocks up the MOST?

(A)  A lower risk of a "Fiscal Cliff" meltdown

(B)  A lower risk of a China Hard Landing.

(C)  A lower risk of a European Financial/Debt Crisis.

(D)  A lower risk of a U.S. recession.

(E)  Other

Second, what is the most likely fear factor to REVERSE matters this year?

 

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