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Written By Briton Ryle

Posted November 27, 2013

It must be something in the water here at Angel Publishing HQ…

Just a few weeks of exposure to our investment brain trust can turn an intern into a trading whiz.

To protect the innocent, I will call our now-wealthier intern Bartholomew.

On Monday of this week, a few of us editors were marveling at a massive 60% jump by a small Israeli 3D printing stock called Camtek (NASDAQ: CAMT).

The company had announced a new type of 3D printer that can print computer circuit boards. The stock jumped from $2.70 to the $4.50-$5 range on massive volume.

As we mulled the implications of printed circuit boards, Bartholomew was quietly filling an order for shares at $4.50. The next day, Camtek opened at $6.20.

Bartholomew nailed a 37% gain literally overnight.

Now, if you know anything about 3D printing stocks, you know they’ve been big movers. In fact, you could say there’s a bubble for 3D printing stocks. And the thing about bubbles is that the stocks can make huge short-term moves.

Our very own Nick Hodge started recommending 3D printing stocks two years ago. He led his Early Advantage readers to 53% on 3D Systems (NASDAQ: DDD), 59% on Stratasys (NASDAQ: SSYS), and a whopping 245% on Organovo (NASDAQ: ONVO).

Of course, being a responsible profiteer, Nick got his readers out of these stocks as the bubbly condition pushed them to record highs.

That didn’t sway our intrepid, risk-tolerant Bartholomew.

That’s the way it is when bubbles emerge. If you’re fast and you know what to look for (good story, large volume), you can make a lot of money. The key is to get in and out quickly.

Bartholomew nimbly took his gains.

It shouldn’t be a surprise if Camtek crashes and leaves a lot of day traders holding the bag, because that’s the way it is with bubbles.

Anatomy of a Bubble

This might sound strange, but it’s a positive sign for the stock market when stocks in speculative/emerging sectors start acting bubbly. It shows that there is some optimism. And it shows that investors are coming back to the market.

The latest ETF and mutual inflow data confirms individual investors are coming back to the market, too.

Now, I’m not suggesting you should go looking for bubble stocks. That’s not a very sound investment strategy.

But make no mistake; the stock market in general is not a bubble.

And the fact that certain stocks — like 3D printing stocks — are kinda bubbly is a good sign for the overall market.

A bubble can be defined as a phenomena wherein positive sentiment pushes equity valuations to unsustainable levels that are completely detached from even the most optimistic fundamentals.

Bubbles happen when you hear phrases like, “It’s different this time,” and “We’re at the end of the boom/bust cycle.” Bubbles happen when economic (and earnings) growth seems like it can continue forever.

It’s pretty safe to say that’s not where we’re at right now… not by a long shot.

Investors have been looking over their shoulders for the next economic crisis since the market bottomed in March 2009.

European debt crisis, mass foreclosures, municipal bonds, bank balance sheets, quantitative easing, Congress, government debt — each of these were supposed to usher in a new financial crisis. Instead, any weakness associated with these catalysts has proven to be a buying opportunity.

Now the biggest threat is that we are in a stock market bubble. So far in November, people are using the search term “stock bubble” more than they ever have.

The bears say it’s a bubble because the Fed’s QE has over-inflated valuations. Don’t believe it.

Here’s why…

It’s All About Earnings

In the short term, stock prices can go in any direction. Rallies and sell-offs often have no discernible logic.

However, over the long term, stock market valuations are driven by one thing: earnings. When earnings grow, companies are worth more and stock prices rise.

These days, and for the last few years, investors have had a hard time reconciling earnings growth with the stagnant economy and high unemployment. How can earnings continue when people aren’t buying stuff?

Well, the fact is by the time 2013 is over, the companies of the S&P 500 will have made $107-$108 a share. That’s a record. And the S&P 500 is trading for about 18 times that, right at its historical average.

For comparison’s sake, when the Internet bubble popped in March of 2000, S&P 500 earnings were half that, around $54 a share; and the P/E was 35.

Next year, 2014, S&P 500 earnings are expected to hit $121 a share. At the current P/E, that offers targets of 2,177 for the S&P 500 and 19,200 for the Dow Industrials.

To those who say the analysts are likely wrong, that there’s no way earnings can grow that much…

Here’s a great chart from the awesome economist Ed Yardeni:

2014 earnings

This chart shows that earnings estimates since 1986 have been wrong twice, in 2000 and in 2007. Otherwise, estimates are a solid indication of what’s coming up.

Now there’s one more chart you need to see…

This one is from Tom Lee, JP Morgan’s Chief Equity Strategist:

pmi

This chart shows how earnings respond to global manufacturing activity, as measured by global Purchasing Managers Index, or PMI.

As you can see, earnings follow the PMI pretty closely.

Right now, however, there is a divergence. Global PMI has turned higher — but earnings estimates have not.

If this chart is correct, then earnings estimates right now are too low.

Instead of being an over-valued bubble, the stock market may actually be undervalued by as much as 20%.

I realize this goes against most of what we hear in the financial media.

However, we at Angel Publishing are committed to bringing you information you can actually use. So keep reading for more no-spin investment ideas and financial analysis.

With that, we wish you and your family a happy Thanksgiving,

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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