We started 2010 projecting the Standard & Poor’s 500 Index would reach 1330. After the year-end numbers settled, we revised our projection to 1300 in mid January. Now, as of the close of the market on Wednesday, December 29, 2010, the S&P is at 1260. We are looking at a pretty sturdy 12% for the year. Through third quarter, 2010 had 2.6% growth in the economy. With the recent tax laws and temporary tax cut extension, we see gross domestic product growing slightly faster in 2011, at 3% to 3.1%.
We expect to see better interest rates on bonds in 2011. We would not be surprised to see about a 1% increase in rates throughout the year. We have been seeing some inflationary numbers, and it is likely The Fed will chase inflation down by raising the target interest rate. It is difficult to not discuss inflation, as we have seen gas prices go up $0.40 a gallon and oil is at $91 a barrel.
Approximately two months ago, investors had to extend to 2018 to get a positive yield on a Treasury Inflation Protection Security. Last week it had come down to 2016. Today, while it yields 0.01%, you can get a positive yielding TIP in 2015. This may indicate inflation fears are waning. We are also beginning to see better returns on municipal bonds. In the last two weeks, we have been able to buy municipal bonds for clients with a tax-equivalent yield of more than 5% with eight- to 10-year maturities for high-income tax bracket investors. We expect in 2011 that we will be able to fulfill many of our clients’ fixed income needs for our Ten Year Rule philosophy.
Because it is a typical pattern for interest rates to rise as the economy expands, we expect The Fed to be proactive and raise the Fed Funds rate. With the steepening of the yield curve, we also expect to see investors moving from short-term bond funds into long-term bond exposures.
Now, with our scenario of lower taxes—investors will see a 2% reduction on Social Security Taxes and income tax rates will remain the same—corporations doing well and spend money and hiring more workers, if all this is true, we project the S&P 500 should reach 1425 in 2011, which is a 13% rise. We expect earnings to be around $95 for S&P companies, and the multiple on that would be 15 times. We expect earnings to rise around 14% and to return to an environment where PE has traded historically with expansion.
If the S&P 500 were to reach a new all-time high, that would put it at 1565. Given earnings of $95, the PE would have to be 16.5, which is surprisingly, not unrealistic. Over the last five years, average PE has been 16.2, which is all predicated by corporate earnings.
Generally, we target 12% growth, as that has been the long-term average for stocks. Starting at today’s 1260, 12% growth would put us at 1410 by the end of 2011. This does not include dividends. The S&P companies pay an average of 2.3% in dividends, plus a 12% gain, we could be looking at 14.3% overall. At that rate, money doubles every six years. With interest rates rising and bond prices falling, many investors will move back to equity investments.
What could hinder our target of 1425? Higher taxes, consumers not spending, and most importantly, companies not hiring. A slow drop in unemployment could potentially be the wrench in the machine. We have seen an increase in private hiring. However, many governments are still in trouble, and need to lay off employees to meet budget cuts. If anything prevents the S&P from reaching our target of 1425, we feel it will be unemployment.
So overall, our predictions for 2011: GDP up 3%, S&P at 1425 and interest rates up 1%.
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