Perhaps the most important indicator to monitor is private-market credit spreads. Spreads have fallen, but are currently still at crisis levels. A continuation of the trend towards the normalization of spreads will virtually assure a massive stage II of the current equity-market rally.

Add one more indicator: earnings revisions. I highlighted this factor in Op-Ed: The Earnings Revisions Circus. Historically, earnings revisions have lagged market prices. However, with earnings revisions trending strongly from a low base, this should provide a favorable wind behind the market’s sails for quite a few weeks to come. Many analysts -- in order to gain publicity and redeem themselves from having missed the rally thus far -- will be making dramatic revisions to EPS estimates and target prices. One needs to get out in front of this trend.

How Far Can the Rally Go?

In Op-Ed: Your S&P Roadmap, I showed that, based on normalized earnings, a “normal” range of valuation for the S&P 500 would be between 950 an 1,350. That means this market has a great deal of room to run before it starts looking “overvalued.”

In any event, valuation isn’t the main factor to look at now. In a strongly trending market, when valuations are within “normal parameters,” valuation becomes a secondary or tertiary consideration.

There are 2 things that matter right now: First, the flow of fundamental news is extremely positive. Second, cash allocations are at all-time highs. As cash starts to move back into equities through institutional mechanisms, there will be virtually nothing that can stop this market.

Fundamental Risks

There’s one main risk that rises above all the others: A precipitous rise in long-term government-bond yields to a level significantly above 4.00%. This would signal a loss of confidence in the ability of the US government to execute its fiscal and monetary stimulus program. I don’t believe that such a development would be fundamentally warranted at the present time. However, this is more a matter of psychology than fundamentals. Thus, it's an unquantifiable risk. If this happens, all bets are off.

(See Is a Counter-Trend Rally Inevitable for other potential risks; there, I discussed IYM, JNK, CYC, CFT, GSP, GSG, DJP, JJC, and BDD.)

The other major risk to my outlook is the obvious one: I could be wrong. That's why I have a checklist. If my various hypotheses are falsified, I'll examine things again. For example, if the economic data don’t continue to show strong momentum, I'll have to reassess.

Conclusion

The market is recovering from an unusual and vicious financial crisis; this is a time in which market participants, after having been petrified, are starting to come to grips with the fact that Great Depression II is probably not going to happen.

This is also an extraordinary time - one in which vast numbers of market participants are wrongly over-allocated to cash. As investors adjust their asset allocations to account for new realities, the rally in financial markets will be extremely powerful.

Indeed, because of the large cash allocations, there’s the danger that at some point, things could get out of hand on the upside. Because of the effects of massive inflows by institutions that invest mechanically and are essentially insensitive to fundamentals, the market could overshoot to the upside, failing to properly account for the risk (as opposed to the certainty) that things could get materially worse in 2010.

However, we’ll worry about the risk of bullish overshoot later. As I point out in Op-Ed: The Crisis is Over - For Now, the financial crisis is over, for now. And for now, I believe this market is going higher - much higher.