You wonder how long this rally can last? So do I.
To get a little more serious, I took a deeper dive on that subject. The chart below is derived from our Zacks Research System (ZRS).
It shows the Forward 12-Month Price to Earnings or P/E ratio for each of the ten S&P 500 sectors, plus the S&P 500 index composite price. A ZRS equity risk premium over the last three years is in blue, running along the bottom of the chart.
ZRS Data from March 2010 to March 2013
The Yellow line at around a 14 forward 12-month P/E ratio is the S&P 500 composite. The Purple line is Telco’s forward P/E at the top, now around 18. At bottom, Energy and Financials forward P/E is in Pink and light Grey around 12.
Look at the S&P 500 Index in bright green, the equity risk premium in light blue at the bottom, and the tilt up and down in sector P/E valuations over the last three years.
Notice anything? I do.
The equity risk premium peaks at S&P 500 bottoms, and stock valuations tilt up from bottoms. That makes perfect sense.
Our ZRS Equity Risk Premium moved from just over 6% four months ago, to about 5.3% now. Macro event risk reduction is the core driver of stocks in the latest rally, much like the last two rallies. Note: ZRS used the AAA corporate bond rate at 3.9% for its risk-free rate, not a risk-free Treasury rate.
So why care?
Because if you look, we saw a six-month rally in 2010 after the first bout of the Euro crisis, a six-month rally again in 2011 after a second bout caused by Greece and Spain, and now one “Fiscal Cliff” recovery starting in November.
The previous two rallies went six months. We are in this one four months. That means to me that we may have two months of this rally to go.
Sell in May and go away?