On Monday the Standard & Poor’s 500-stock index traded above 2,000 for the first time, getting to just under 2,002 before retreating below the 2K mark in early afternoon. Should you cheer? Or panic?
Momentum traders should be excited about all this. The index has almost tripled from its low in March 2009. People have made a lot of money over the years by following the edict that “the trend is your friend.” Stocks had some pullbacks in 2011 and 2012, but since the start of 2013 they’ve been in a strong, steady uptrend. A rally like this could have a long way to go.
For contrarians, however, it must be time to sell. “The United States stock market looks very expensive right now,” Yale University economist and Nobel laureate Robert Shiller wrote in a widely read article for the New York Times on Aug. 16.
Among typical investors who are usually neither one nor the other, there’s a compelling case to ignore the zigs and zags of the market and simply sit tight. Brad DeLong, a University of California at Berkeley economist, produced the following charts, which show two very different perspectives on the stock market.
The first shows the Campbell-Shiller cyclically adjusted price-earnings ratio (CAPE), which measures how high companies’ stock prices are relative to the profits generated by the companies themselves. The sharp ups and downs seem to make a good case for bailing out when stock prices appear high:
But DeLong’s second chart, showing the cumulative return on stocks, makes the case for sitting tight. The vertical axis is on a ratio scale, so a steady percentage increase in stocks shows up as a straight line. Notice how even the stock market crash that helped kick off the Great Depression shows up as only a blip in the powerful rise of the market:
As Bloomberg reports, the flirtation of the S&P 500 with 2,000 points today has a host of short-term explanations. European Central Bank President Mario Draghi hinted at more monetary stimulus to boost growth, and there are signs of more corporate takeovers. That’s all good to know if you’re a close follower of the financial markets. But if you don’t need to draw on your savings anytime soon, SPX2K is no more significant than Y2K was 14 years ago.