Don’t bet against the bull
The Dow Jones Industrial Average breached 22,000 for the first time last week despite dysfunction in Washington, an increasingly belligerent North Korea, and a looming showdown over raising the federal debt ceiling.
Eight years and five months into history’s second-longest bull market, pundits say the table is set for the rally to continue. But they’re recommending caution and discretion.
“There’s no reason the market can’t go up another 10 percent by the end of next year,” said Greg Melvin, chief investment officer of C.S. McKee, Downtown.
Geoffrey Gerber of Twin Capital Management in McMurray noted that the S&P 500 has produced positive total returns monthly since the November election and in 16 of the last 17 months. Similar nine-month and 17-month stretches have happened only three other times since February 1962, he said.
The streaks make Mr. Gerber nervous, but not nervous enough to think a 20 percent correction — the definition of a bear market — is imminent.
“Sometime in the next three months, we’ll have a dip,” he predicted. “I do think we have a way to go [up], but today I would not be betting the farm.”
Low interest rates designed to lift the economy out of the Great Recession instead drove yields on fixed income investments so low that investors flocked to stocks and other risky assets. Other factors also have allowed the aging bull to persevere.
“There’s also been a little uptick in the economy and also a fairly strong year for corporate earnings,” said John Frankola of Vista Investment Management in Wilkins.
Corporate earnings grew 9.1 percent in the second quarter and are expected to be up 9.5 percent for 2017, according to investment research firm FactSet. Earnings have been boosted in part by companies repurchasing large amounts of their shares. S&P 500 companies bought back about $536 billion of their shares last year and
$572 billion in 2015, according to S&P Global.
Strong earnings have driven price/earnings ratios, a measure of how much investors are willing to pay for earnings, to lofty levels. The S&P 500 is currently trading for nearly 18 times what the stocks in the broad market index are expected to earn in the next 12 months vs. a 10-year average of 14 times earnings, according to FactSet.
“Earnings multiples are fairly high. They’re not as crazy as they were in the 1990s, but they’re certainly high,” said Malcolm Polley, chief investment officer of Stewart Capital Advisors in Indiana, Pa.
He said the high valuations have made it difficult to find stocks that are not overpriced.
When price/earnings ratios reached this level in the past, interest rates were much higher. Because higher rates cheapen the value of earnings, that means price/earnings ratios are not as high as they seem, according to Ron Heakins of OakTree Investment Advisers in Shadyside. Mr. Heakins sees no signs of the “irrational exuberance” that then-Federal Reserve Board Chairman Alan Greenspan noted in December 1996, a little more than three years before that bull market ended.
“I don’t see excesses inside this business cycle yet,” he said.
Nor do Mr. Heakins and many others see signs of a recession on the horizon.
Inflation is under control and most do not expect the Federal Reserve’s plans to gradually raise short-term interest rates will suddenly shift into high gear. The Fed’s current target rate is 1 to 1.25 percent and its longterm mark is 2 percent. That makes certificates of deposit, money market funds, and other fixed income investments unattractive and encourages investors to continue looking to stocks.
“Until Fed funds get to 2 percent, you’re losing money on your cash,” Mr. Melvin said. “Fixed [income] is just slow death.”
He thinks a recession could still be at least two years off. While others believe a downturn could come sooner, the near-term horizon looks sunny and bright according to most economists.
The rosy outlook notwithstanding, Mr. Frankola said investors should develop a plan for what they will do when the market turns, even if it is only a temporary setback. Mr. Polley advised investors to be price conscious.
“Look at what you’re paying for cash flow and growth in cash flow,” he recommended.