A short while ago, your car overheated traveling at 40 mph uphill on a gravel road. You are now traveling at 45 mph on a flat paved road.
Are you worried your car will overheat? After all, you are currently traveling faster than you were the last time you stalled.
Since the road conditions are different now, you are likely not very worried at all.
This is what many are saying about the recent string of new all-time highs struck by U.S. market indices. While some anxiously point to the charts calling out, “Remember what happened the last time we were here?”, others remain coolly unconcerned. By their estimations, these recent new highs don’t really mean very much at all.
“As the S&P 500 continues to hit resistance near its record closing high of 1,565.15 set on October 9, 2007, investors are spending a lot of time talking about where stocks are relative to all time highs,” addresses Yahoo! Finance’s investing show Breakout. “But the dirty truth is they don’t matter at all. Not even a little bit,” it determines.
The show’s guest, Lee Munson, chief investment officer at Portfolio LLC and author of Rigged Money, agrees, pointing to several reasons “not to make too much of where the market is relative to history,” as Yahoo! Finance puts it.
Of the multitude of points that can be raised when putting today’s stock market levels into perspective, perhaps the two most important are inflation and the place in the economic cycle at which the U.S. is currently.
Regarding how inflation factors into the comparison between the S&P 500’s current highs and its previous highs, Yahoo! Finance points out that “inflation rates have been subdued over the last decade plus, but years of compounding add up. Running the numbers through a simple online inflation calculator shows the S&P 500 is still more than 10% off its 2007 high, and that all-time high isn’t usually measured against 2000 when the S&P got over 1,500 for the first time.”
ABC News concurs, noting where the inflation-adjusted high really is. “When inflation is taken into account, the S&P 500 is still far from its peak. On March 24, 2000, the index hit 1,527. With inflation added to it, that peak works out to 2,065, according to calculations from JPMorgan Chase.”
Even though we are comparing the same notches on the index, we get different values in our investments’ buying power because of all the other things that have happened to the economy between then and now. We often note the dollar’s changing buying power with time. The same can be done with stock indices, just to put their current levels into proper perspective.
The other key factor to getting an accurate reading on a stock market’s temperature gauge is to note the current place within the economic cycle.
“To that point,” continues Yahoo! Finance, “Munson makes the case that the U.S. could be in the middle of an elongated business cycle. For whatever reason (most likely the Fed) business cycles have been extending. The result is a seemingly endless recession leading to a long but almost imperceptible recovery.”
And if the cycles of bust, to boom, back to bust again are getting longer, as Munson opines, then it really shouldn’t matter if an index or two are at their all-time highs. There could still be a few more years of growth to come.
“We may be seeing three, four, five years of economic growth,” Yahoo! Finance quotes Munson. “We’re hitting ‘all-time highs’ in the middle of a business cycle not necessarily at the end.”
So even if your car has reached 45 mph, this smoother pavement still has plenty more miles to go before hitting gravel again. That means not even 50 mph would stall you now.
Regarding the currently smoother and flatter road, ABC News explains that “since the S&P 500 bottomed out in March 2009, the economy has pulled out of a recession and started growing. Companies are making record profits quarter after quarter, they’re hiring in greater numbers, and the housing market is finally recovering. The economy has expanded for 14 quarters in a row.”
“Profits keep climbing,” it adds. “Earnings for the S&P 500 hit $103 per share last year. That’s up from $84 in 2007 and $61 in 2009.”
Even if some traders attribute this smoothness to the Federal Reserve’s helping hand, it really doesn’t matter. The fact of the matter is the road is smoother and flatter than it was the last time the indices were at these levels.
Mark Luschini, chief investment strategist at Janney Montgomery Scott, adds “This isn’t all smoke and mirrors. Corporate profits are at all-time highs,” – quotes ABC News.
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So if you think the markets are overheating right now because their values are the highest they have ever been, they might not really be overheating at all. They’re just driving on a smoother road surface, even if it is thanks to all the stimulus provided by the Federal Reserve and exceptionally low interest rates. The markets can move higher still, and for some time.
There is still one more important point to add here. The recent run up in stock indices over the past 4 years has often been referred to as “the most denied rally in years”. I’ve also heard it called “the most hated rally”. Why? Because so many traders and investors have missed it. It casually crept up on everyone without much expectation.
This actually strengthens the case for higher moves, since there is an absence of “hot money” or “speculative bets” that are often the cause of overheating.
As Laszlo Birinyi, president of Birinyi Associates Inc. in Westport, Connecticut, explained to Businessweek, “As long as you have this sort of hesitancy or reluctance instead of acceptance the positive case is still very much intact.” “Don’t go looking for the exit. Leave the door open for a good year, because that is the one possibility that I do not hear.”
Of course, entering the stock market at this point in the game would be increasingly risky. Even if these aren’t all-time highs, they’re high enough for many investors to start acknowledging the age-old cliche, “What goes up must come down.”
In the end, a stock’s price is merely what the general trading public is willing to pay for it – at this particular point in time, and at this particular place in the economic cycle.
And though we will hit those bumps on the road from time to time, we still drive our vehicles based on what we see happening around us here and now, not based on what we saw happening on a completely different road many miles behind us.
Incidentally, the same thing could be said for gold. Although it’s recent 2011 spike to $1925 was gold’s all-time high, in actual buying-power last year’s spike stopped far short of 1980’s spike to $850. When adjusted for inflation over the past 33 years, gold’s 1980 high of $850 represents $2,400 in today’s money.
At just under $1600 an ounce at the writing of this article, gold can still climb another $800, or some 50%, before reaching 1980’s true worth. It is by no means in bubble territory.
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