Health Care Review...: Market as undervalued today as in 1990 Commentary: Norm Fosback is as bullish today as 20 years ago

CHAPEL HILL, N.C. (MarketWatch) — The stock market represents better value today than at any time in the last 20 years?

That certainly is not something you’ve been reading recently in this column. For example, I’ve argued that, from a very short-term point of view, there is too much complacency out there — which is bearish from a contrarian point of view. ( Read my Jan. 18 column, entitled “Worrisome complacency.” )

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And I’ve also pointed out that some longer-term valuation measures with good track records — such as the Cyclically-Adjusted Price Earnings Ratio, or CAPE, made famous by Yale University Professor Robert Shiller — show the market to be closer to the overvalued end of the spectrum than undervalued. ( Read my Jan 6 column, entitled “What if the 2009 bull market is still alive?” )

But it’s important for everyone, and especially contrarians, to consider contrary points of view. And this is particularly the case when the point of view is being advanced by someone with as long and eminent a record as Norm Fosback.

Fosback, for those of you who don’t know, has been a close and scientifically minded student of the stock market for nearly five decades. For three decades he was the head of the Institute for Econometric Research, during which he authored a widely followed investment textbook entitled Stock Market Logic and edited several investment advisory services. He currently publishes a service called Fosback’s Fund Forecaster.

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Dow posts first loss in a week

Blue-chip stocks finish in the red for the first time in five sessions, while the broader market trades flat, as investors watch Europe for developments in its debt crisis. Photo: Reuters

In the latest issue of that service, published late last week, Fosback boldly states that “the market’s fundamental position has evolved to the most favorable alignment in 20 years.”

His econometric model is projecting that the stock market will rise by 19% over the next 12 months, and 89% over the next five years. That five-year rate is equivalent to nearly 14% per year on an annualized basis.

While Fosback’s model incorporates numerous different indicators that he has found to have predictive abilities, he says that the major underlying issues for the U.S. market right now are “domestic corporate profits, valuations of domestic stocks, and Federal Reserve policy.” This is what Fosback has to say about each:

Corporate profitability is an all-time high. “Not only have pretax profits soared to match their highest levels in history, but plunging effective corporate tax rates have sent after-tax corporate profits soaring to even greater heights compared with historical norms... With after-tax profits running at 10% of the nation’s $15-trillion GDP, net additions to business cash coffers are running at least 1-1/2 trillion on an annual basis, even after dividend payouts to stockholders. At the moment, that is effectively doubling cash holdings on an annualized basis. Liquidity, in other words is enormous.”
Despite these record profits, the P/E ratio on the S&P 500 index is back to where it stood in 1990 (when calculated on the basis of operating earnings). The decade of the 1990s, of course, was one of the most bullish in U.S. stock market history.
“Monetary policy [is] still in an aggressive easing mode.” Interest rates remain “at record lows” and the money supply is expanding.

What about Europe? Won’t slowing economic growth in that crucial region sabotage the U.S. market, even if it were otherwise poised for a major bull market?

Fosback thinks not, arguing that the media’s obsession with Europe is little more than a “sleight of hand: Look over there ... while the real action is right here.”

Are there any flies in the ointment?

Of course.

Ironically, though, the major such fly that Fosback acknowledges derives from how good things otherwise are right now for corporate America: “The only meaningful negative investors can take away from the current corporate profit and tax environments is that they are so favorable it is almost inconceivable they can get any better; in other words, the path of least resistance for corporate profits going forward may be down, simply because it is almost unimaginable it can get any better.”

But even if corporate profit growth slows to a standstill, which he thinks is most unlikely, the market is still likely to go up because of rising P/E ratios.

Needless to say, you might not agree with Fosback’s cheery assessment. But regardless, and especially if you don’t, you need to have good answers for why the factors he mentions aren’t as bullish as he believes them to be.

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Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.