5 Reasons Stocks Should Keep Climbing
Just because stock valuations are high doesn't mean they can't still go up from here.
No matter how you slice the numbers, today’s stock market is richly valued. The price-earnings ratio of Standard & Poor’s 500-stock index is 18. That makes this the second-most-expensive stock market since World War II, surpassed only by the 1990s bull market. And it’s based on analysts’ estimates of earnings for the coming 12 months—which are typically overoptimistic.
But high stock valuations almost never kill bull markets. The 2000–02 tech wreck is the exception to the rule, but back then the P/E of the S&P 500 was approaching 30 and P/Es of some tech stocks hit triple digits. Indeed, many tech stocks had no earnings. More than a few had no revenues.
High valuations, such as P/E ratios, do give an indication of how far the market might fall in the next bear market. But selling now because valuations are high may well leave you watching from the sidelines as stock prices continue rising.
This bull market is now the second-biggest in history, with the total return of the S&P 500 gaining a whopping 354% (an annualized 19.2%) since March 9, 2009. Only the 1990s saw a bigger bull market advance: 546% (an annualized 21.8%). The current bull market has also lasted a remarkably long time. It’s 8½ years old, making it the second-longest bull market in history, going back to the 1930s. But old age alone never spells the end of a bull market. (Returns and other data are as of October 19.)
Why do I think this bull market will keep going? Here are five key reasons.
1. A strong economy. True, the economy has been growing at a subpar rate of roughly 2% annually, after inflation. But the growth has been steady for years now—with little or no sign of the kind of excesses that typically cause an economy to derail, largely because the current recovery has been slow and steady. Growth has accelerated a bit of late, but there’s scant evidence of the economy overheating.
Jim Paulsen, chief investment strategist at the Leuthold Group, notes that the current economic recovery, like the bull market, is in its ninth year. The only longer recovery was the 10-year recovery of the 1990s. However, Paulsen says, “Recoveries do not die of old age, but rather of questionable character.” Based on his readings of the economy, the current recovery is on solid ground. It’s “no longer a puppy but appears much younger than most perceive.”
Bear markets almost never occur without a recession on the way. Usually, the market turns down before the economic downturn begins. But Jim Stack, editor of the InvesTech Research newsletter, says that most indicators of the economy’s future health are pointing up. The Conference Board’s index of Leading Economic Indicators, which is designed to predict economic conditions six months in advance, has registered higher readings in each of the past 12 months. Similarly, the Institute of Supply Management’s measures of both the manufacturing and service sectors of the economy have been climbing steadily. The combined reading for the two sectors is now at a 13-year high.
Meanwhile, inflation remains subdued. The Federal Reserve has been slowly raising interest rates because the economy is healthy. But as long as inflation shows no signs of picking up dramatically, there’s little danger of the Fed having to raise rates at a pace that risks choking off growth and pushing the economy into recession.
2. Earnings growth. The stronger economy has helped propel U.S. corporate earnings higher this year. More stocks are reporting higher-than-expected earnings. That’s a huge plus for stocks. (Theoretically, earnings could rise enough to make price-earnings ratios look reasonable, but that would require a dramatic boost in earnings).
3. Global synchronized growth. The major economies around the world are almost all growing. Europe seems to have survived its debt crisis and is growing nicely. Even more surprising, Japan’s economy is showing signs of life, too. In October, the Nikkei 225 hit its highest level since December 1996. China and other emerging markets are also doing well. The International Monetary Fund predicts the global economy will grow 3.6% this year and 3.7% in 2018.
4. A healthy market. Market technicians try to forecast the future based on the action of the market itself. Currently, technicians see a healthy market. Toward the end of bull markets, a relative handful of stocks are often the only ones rising. The bull market in the early 1970s narrowed to the “nifty fifty” stocks before it cratered. In 1999 and early 2000, the bull market similarly narrowed, mainly to technology and telecom stocks, before it collapsed.
In a healthy bull market, the advance is broad with most stocks rising. That’s the case today. The S&P, Nasdaq, Dow Jones industrial average, Dow Jones transportation average and small-company Russell 2000 index have all set record highs recently. Far more stocks are advancing than declining, and many more stocks are setting new 52-week highs than new 52-week lows.
It may look like the FAANG stocks—Facebook (FB), Amazon.com (AMZN), Apple (AAPL), Netflix (NFLX) and Google’s parent, Alphabet (GOOGL)—have driven much of the gains, but the current rally is widespread. Tech stocks, up 30% this year, are leading the pack, but nine of the 11 S&P sectors are in positive territory this year, with seven sectors ahead in double digits. Only energy and telecom have lost ground this year.
5. Worldwide stock gains. The bull market is now a worldwide one. The MSCI World index of stocks in 23 developed countries hit a new record high in October. Just this year, the MSCI index has returned 18.0%, compared with 16.3% for the S&P. Emerging markets are doing even better. The MSCI Emerging Markets index has returned a sizzling 32.0% so far this year. Indeed, if U.S. stock valuations make you nervous, this looks like a propitious time to add to your investments in foreign stocks, which are much cheaper.
Of course, there are always things that could go wrong and trip up the stock market. If the war of words with North Korea erupts into a war, look out below. Margin debt—the amount speculative investors are borrowing against stocks and bonds they already own to buy more stocks and bonds—is at record highs. If stocks begin falling, those traders might be forced to sell, triggering a vicious cycle. Likewise, if the dysfunction in Washington kills the effort to cut taxes, investors’ mood could sour.
One of these factors, or something else that isn’t even on our radar screens, will eventually be the catalyst for the next bear market. But for now, the positives far outweigh the negatives.
There’s this, too: Most bull market tops are slow, rounded affairs, playing out over a matter of weeks or months. When the market is getting ready to tank, it typically gives plenty of warning that it may be time to cut back on your stock holdings.
Steven Goldberg is an investment adviser in the Washington, D.C., area.