Investors in the U.S. stock market seemed to have a classic case of “bubble-phobia,” loosely defined as “fear that this bull market will collapse in a similar fashion to ones in the not so distant past.” These symptoms can afflict both the experienced professional as well as individual investors and include a failure to commit an appropriate percentage of assets to stocks based upon a fear that the current bull environment is unsustainable. This “bubble-phobia” can further manifest itself in a lack of action by the investor thereby keeping said investor out of the stock market and reducing one to being reactive rather than pro-active.
Our prescription for the above referenced malady is simple – set up disciplines and follow those disciplines. One way or another, decisions are made. Either you make them, or through procrastination, they are made for you.
To help ease your case of “bubble-phobia,” we point to several reasons why the stock market is not in a bubble. First and foremost, investors can feel comfortable that relative stock valuations are reasonable. The thirty stocks that comprise the Dow Jones Industrial Average are expected to earn an aggregate of $945 this calendar year. With the Dow trading at just over 11,800 this places the Dow’s Price-to-Earnings (P/E) Ratio, a common tool used for valuation, at 12.5, somewhat below the normal historical range.
Corporate profits benefit from a stable interest rate environment, one which makes for a more healthy current business climate as well as enabling business to better predict future trends. Over the past two years, the ten-year U.S. Treasury Note has traded between 3.00% and 4.00%, very predictable indeed. Furthermore, the Federal Reserve appears to be on hold with regard to raising interest rates. In fact, some believe that the next move from the Fed will be to lower rates.
At this time, rampant inflation appears not to be an issue. Due to the slack in the economy, both the Consumer and Producer Prices Indices, key measures of inflation, are subdued and now, with oil trading somewhere around $90 per barrel, the pressure on manufacturers and service providers to raise prices appears to have ebbed.
The leading stocks over the past few months have been quality companies with sound earnings and foreseeable growth in corporate profits. They have not been speculative companies. Historically, a market led by the “blue chip” companies, usually has not reached its peak. It is when it is led by the speculative companies, those that retail investors like, the market has historically topped out.
Finally, retail investors have not fully embraced this rally. As long as “bubble-phobia” continues to persist, there is most likely room left to run. At this point in time, stocks are still climbing that venerable wall of worry. At this time and if history is any guide, after a brief, relatively shallow pullback, we look forward to strong stock market at least over the first half of 2011.