St. Louis-based investment group Stifel Nicolaus sees U.S. GDP recovery lifting the S&P 500 to 1,600 in 2H12. Bullish what? That’s about  20% above current levels. According to the firm, “the U.S. rebalancing borne of crisis is 3-4 years ahead of the eurozone and China, enforcing a U.S. playbook,” to be led by Financials and Tech stocks at the expense of bond equivalent equities (Utilities, Communications).

Here is their rationale:

• The U.S. wrote the playbook for addressing the eurozone crisis, and overcoming their resistance to the U.S. prescription of coordinated fiscal and monetary policy response has been the challenge.

• Inflation lowers P/E ratios, and deflation dims EPS, but navigating the extremes of inflation and deflation, which we see in 2H12, as well as loose monetary policy as the offset to fiscal tightening, is the sweet spot for equity we see.

• We realize S&P EPS supported by the Treasury and Federal Reserve are of lower quality, but investor confidence that policy will be sustained could lift stocks and lower the Equity Risk premium, which is near 40-year highs.

• We believe the top will be evident when Financials (note lending is late cycle in de-leveraging) beat the worst performing sector (probably Utilities, a bond proxy) by the “normal” ~45% gap between the best and worst groups.

• If we are wrong in 2H12 it may be due to the Fed being out-gunned by deflation – a liquidity trap, or recession. We see that as a mid-decade, but secular bear markets require that we view the future as a series of short-term trades.

• Commodity stocks may bounce on European euro-crisis confidence (stronger euro, weaker dollar) and Chinese stimulus, late 2012 events we expect, but we think commodity-related economic profit has peaked, so we are wary.

• There is precedent for weakness overseas, domestic GDP traction, capital flows to the U.S., a surging dollar, U.S. P/E expansion, Europe struggling with currency union and cheaper fuel – it was the equity-friendly “late 1990s.”

According to the firm, this is the 4th “Secular Bear Market” in the past century (see 1st chart), each of which de-capitalized equity as a percentage of GDP from elevated starting points (1907, 1929, 1968, 2000). The note also says the following:

“Within secular bear markets there are rough “stages” of investor psychology (see 2nd chart), and we see a “Late Bull” momentum phase and rally to 1,600 (only slightly higher than the 2007 and 2000 peaks).”



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