Will stocks keep climbing?

In 2014, stock markets have continued the run that started in 2009. The S&P 500 Index® has notched dozensof all-time highs and broken through the 2,000 level for the first time, as the economy has shown signs ofstrength and corporate profits have continued to creep higher. Still, some investors have grown nervous thatthe markets are due for a correction or that stocks have reached the kind of heights that preceded the majorbear markets of 2001 and 2008.

While no one knows what could happen in the short term, Fidelity growth managers Sonu Kalra, who managesthe Fidelity® Blue Chip Growth Fund, and Gavin Baker, who runs the Fidelity® OTC Portfolio, recently made thecase that stocks could continue to deliver attractive returns over the longer term, thanks to strongfundamentals and secular growth trends.

A different market

Investors who are worried that stocks are overvalued may look back at previous highs nervously. The S&P500® Index was around 1,500 before each of the last two major pullbacks, well below recent levels of 1,960.But things have changed since those previous highs. A key difference has to do with corporate earnings. Backin 2000, the S&P produced $57 in profits per share; today, that level has risen to $114 per share.

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In fact, earnings increases have outpaced stock gains, causing valuations to drop compared with previouspeaks. For instance, in 2000 the S&P price-to-earnings (P/E) ratio was more than 30, while in July 2014 it was17. Still, it is hard to make the case that stocks are cheap today. The average P/E ratio since 1926 has beenabout 15, and in 2009 the S&P traded close to 12.

“I would describe the market overall as fairly valued—but that doesn’t mean we can’t continue to see gains,”says Kalra. “The U.S. economy continues to grow at a slow but steady pace and, historically, bull markets haveended with a slowdown in the economy. But given that we are in the fifth year of a bull market, I do think youneed to be selective about what you own and look for real opportunities.”

The economic backdrop

Ultimately, stock market returns tend to follow corporate earnings. Today, there are some reasons for optimismregarding the outlook for corporations. Revenues have continued to grow in a slow and steady fashion, up4.3% in the June quarter compared to last year. At the same time, mild inflation has been keeping input costslow, and low interest rates have reduced debt burdens and capital costs for many corporations.

All this has translated into higher profit margins, with the S&P 500 delivering 8% net earnings growth in Q22014 compared with the same period a year ago. At the same time, many companies have taken advantage oflow rates to decrease the cost of debts. As that cash has dropped to the bottom line, companies havestockpiled nearly $2 trillion in cash that may benefit investors through share buybacks, dividends, orreinvestment.

Riding a recovering economy

While the economy is far from red hot, the slow, steady gains that have been made may provide some wind atthe backs of corporations. GDP rebounded from a lackluster winter, with 4% growth in the second quarter ofthis year, along with strong hiring reports for the job market. The economy has been benefiting fromimprovements in the housing market, which have the potential to be an enduring change due to pent-updemand, affordable prices, and a lack of supply. The economy has also benefited from big reductions inenergy costs, thanks to new production techniques in the United States, and a resurgence in domesticmanufacturing.

Strategies to look for growth

With stocks fairly valued and the economy expanding, albeit slowly, investors may want to consider seekingpockets of growth that are outpacing the economy overall. Historically, the market has rewarded companiesthat have been able to produce double-digit growth.

“I think we’re going to see more change in the next twenty years then we have seen in the last fifty years,” saysBaker. “It is a great time to be alive and a great time to be a growth investor.”

In this environment, it may be wise to stick with your asset mix, rebalance at least once a year, staydiversified, and—if you are inclined to make more tactical bets—tilt toward corners of the equity market whereyou find growth opportunities.

Learn more

• Sonu Kalra manages Fidelity® Blue Chip Growth Fund
• Gavin Baker manages Fidelity® OTC Portfolio
• Find individual stocks, mutual funds, and ETFs.

Past performance is no guarantee of future results.

The information presented reflects the opinions of Sonu Kalra and Gavin Baker as of August 19, 2014. These opinions donot necessarily represent the views of Fidelity or any other person in the Fidelity organization and are subject to change atany time based on market or other conditions. Fidelity disclaims any responsibility to update such views. These views maynot be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerousfactors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.

As with all your investments through Fidelity, you must make your own determination as to whether an investment in anyparticular security or fund is consistent with your investment objectives, risk tolerance, financial situation, and yourevaluation of the investment option. Fidelity is not recommending or endorsing any particular investment option bymentioning it in this article or by making it available to its customers. This information is provided for educational purposesonly, and you should bear in mind that laws of a particular state and your particular situation may affect this information.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, andindustry group representation to represent U.S. equity performance.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, oreconomic developments. Investing in stock involves risks, including the possible loss of principal.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or losemoney.

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