Improved consumer confidence could see U.S. stocks 20% higher in 2012

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The Conference Board Consumer Confidence Index surged to 64.5 in December from 55.2 in November. This has for the moment removed a serious headwind for U.S. equities. As shown below, the close relationship between Robert Shiller’s Cyclically Adjusted Price Earnings Ratio, or generally known as PE10, and the Consumer Confidence Index since 1998 indicates that the S&P 500 Index is correctly priced at a PE10 of 20.8.

While 2012 will probably continue to see wild gyrations on stock markets, I am of the opinion that the U.S. economy will gradually improve over the next 12 months. I expect consumer confidence to reflect the better economy and work its way higher to the 80 level by year-end. In light of this improvement, I will not be surprised if the S&P 500’s PE10 reach 25 by the end of 2012. This implies a target for the S&P 500 of 1,518 by the end of 2012 – 20% higher than the current 1,263.

But the road ahead will continue to be bumpy as the stock market indices are not at bargain levels, as seen from the Shiller PE10 graph below. In short, the market behavior of the past few days has been fairly constructive, but still somewhat inconclusive (as conveyed in my podcast of two days ago). I believe it is appropriated to have stock market exposure, but will for the time being still err on the side of caution by favoring the dividend paying Aristocrats or ETFs investing in these stocks.

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