2008 should be a good year for stocks

• Invest half of my cash into the Nasdaq-100 exchange-traded fund (QQQQ, news, msgs) at the open.

• Invest the other half of my cash into the S&P 500 ETF (SPY, news, msgs) at the open.

I believe it was the Baron Nathan Rothschild who said to buy when there's "blood in the streets."

I've been sitting in 100% cash for a month (even though there's no credit for interest earned in the Strategy Lab bank) because my sentiment indicators had told me there was too much optimism and complacency among most market participants.

Too many people thought that the Federal Reserve would do whatever was necessary to keep the economy moving, plus there were hopes for a Santa Claus rally. Unfortunately, that never really materialized.

But the pain inflicted as 2007 wound down and as 2008 began is severe enough that my indicators are now flashing too much fear in the markets. So, it's time to buy again.

With the contest due to end in mid-January, I'm not going to try to get cute with individual stocks. Anything can happen to specific stocks in a week or two. But I'm confident the markets as a whole will bounce back, and I want to be exposed now to protect my lead in the contest -- or at least my outperformance against the indexes over these past five and a half months.

That said, let me share some of my outlook for 2008, as I've already done with my readers at BigTrends.com. As always, there are no guarantees, as a lot can change over the next year. However, we have to start somewhere, so . . .

A double-digit election year

The fact of a presidential election year is likely to impact stock values in 2008. In fact, the Dow Jones industrials ($INDU) typically rise between 11% and 15% in an election year. Splitting the difference still means about a 13% gain . . . much better than the average.

Does that fit in with technical analysis of the Dow? Based on the current charts, the low-end likely return for 2008 is 6.2%, while the high-end is 17.3%. The average of those two possibilities is 11.75% -- right in line with the election-year projection.

In other words, the 11%-to-13% return for the Dow does look and feel plausible.

And what about valuation? The average trailing price-earnings ratio for all 30 Dow components is 16.10, but the projection for the next 12 months is 14.10. This is in the middle of nominal levels --- the average P/E for the Dow since 1950 is 16.6.

Historically, a P/E reading that's too high is 22 or above, and too low is under 10. That said, those extreme levels are actually rarely seen. The Dow can move up and down quite a bit and never actually reach those outside P/E readings. So, let's reel in the too high/too low levels to P/Es of 18 and 14, respectively. Even then, we're mostly on track. So, all seems to be acceptable on that front.

Still, it seems like there should be some interim methodology for measuring whether the market is worth it based on forecasts. The best measure we see is to extrapolate the expected growth in earnings. With a current P/E of 16.10 but a projected P/E of 14.10, these companies are basically saying they forecasting earnings growth of 14%.

Is it possible? Yeah, but I also think it's aggressive. On the other hand, stocks don't trade at what they're worth all the time. These companies could grow earnings only by 10%, the underlying stocks could still gain 11%, and the Dow's P/E could still remain under 18.

Though I think the valuation measure is a possible sore spot, I also feel it won't be a major burden on the index.

Will the Democrats scare off voters?

That said, I do have to wonder if the 2008 election will cause the norm to be sidestepped. Despite George W. Bush's record-breaking unpopularity, the Democrats don't have the White House in the bag. Even more stunning is how the Dems have two very strong potential candidates, while the Republicans have no clear front-runner -- at least not yet.

Why does this matter? Two issues are at play here. The first one is change. The stock market doesn't like it, and clearly a move to a Democratic regime would be a far cry from Bush's brand of Republicanism. I think fear of change and a general fear of Democrats could spook Wall Street a little.

And oh yeah -- don't forget most of W's tax cuts will go away in 2008, and the Democrats are apt to let it happen without a fight. It could be that a decisive Democratic victory will be a relief for a recently troubled market, but the brief taste of a diminished tax burden could make voting for Democrats a tough thing to do.

The irony here is that the market tends to perform better under Democrats than Republicans, suggesting that the fears are unfounded. Of course, 2008 isn't a "new administration" year. It's the last year of the "old administration."

It may be a little too soon in the game for investors to worry about who will win the White House. I know I wouldn't make any bets yet. Watch this dynamic as the story unfolds, though. The impact of the election will grow as it becomes clearer who's winning the campaign.

Can the Nasdaq have another strong year?

Let me offer some projections for the Standard & Poor's 500 Index ($INX) and the Nasdaq Composite Index ($COMPX).

The S&P's weakness in 2007, compared with the Nasdaq and the Dow, was just bizarre. A 3.5% gain? The trouble is, when I look at the chart, I don't see a whole lot more than that to get excited about.

My charts suggest a low-end return of about 1% and a high-end possibility of 18.6%. The more immediate cone of movement suggests the same low-end return of -1% and a high-end result of 15.7%.

This is a bit of a problem. The median return for the S&P 500 could be somewhere around 8%. Either the chart's recent (and not so recent) history means very little, or large caps are in trouble. And considering they've been surprising leaders for many months now, it wouldn't shock me to see them start to lag. In fact, they've been lagging of late. Maybe there's a small cap or mid cap opportunity hiding in the charts?

As for the Nasdaq, technical analysis of its chart reveals a world of possibilities. Most are red-hot or ice-cold. The likely high-end return is around 16.9%, and the low-end possibility is 6%. The extreme ends of that range are a gain of 20% or more and a loss of 10.7%.

By the way, the Nasdaq-100's current P/E is 38.7. Before you jump to conclusions, also bear in mind that it was over 200 in late 1999. So we could see much more froth before hitting a headwind.

Still, even by historical standards, that's high. The aggregate projected P/Es suggest these biggest Nasdaq-traded companies are going to increase earnings by 35%. A lot of naysayers say it can't happen, and I understand the reasons why they think so. However, never say never. Besides, a stock's worth and a stock's price rarely meet.

Either way, a lot of planets will have to line up if the Nasdaq is to have another outstanding year.